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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
     SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
     SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 333-191132-02

 

 

APX Group Holdings, Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   46-1304852

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

4931 North 300 West

Provo, UT

  84604
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s Telephone Number, Including Area Code: (801) 377-9111

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of November 13, 2014, there were 100 shares of the issuer’s common stock, par value $0.01 per share, issued and outstanding.

 

 

 


Table of Contents

APX Group Holdings Inc.

FORM 10-Q

T ABLE OF CONTENTS

 

          Page
No.
 

PART I — Financial Information

     4   

Item 1.

   Unaudited Condensed Consolidated Financial Statements      4   
   Unaudited Condensed Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013      4   
  

Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2014 and 2013

     5   
  

Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended September 30, 2014 and 2013

     6   
  

Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013

     7   
   Notes to Unaudited Condensed Consolidated Financial Statements      8   

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      31   

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk      52   

Item 4.

   Controls and Procedures      53   

PART II — Other Information

     54   

Item 1.

   Legal Proceedings      54   

Item 1A.

   Risk Factors      54   

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      54   

Item 3.

   Defaults Upon Senior Securities      54   

Item 4.

   Mine Safety Disclosures      54   

Item 5.

   Other Information      54   

Item 6.

   Exhibits      56   

SIGNATURES

     57   

 

2


Table of Contents

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q includes forward-looking statements regarding, among other things, our plans, strategies and prospects, both business and financial. These statements are based on the beliefs and assumptions of our management. Although we believe that our plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, we cannot assure you that we will achieve or realize these plans, intentions or expectations. Forward-looking statements are inherently subject to risks, uncertainties and assumptions. Generally, statements that are not historical facts, including statements concerning our possible or assumed future actions, business strategies, events or results of operations, are forward-looking statements. These statements may be preceded by, followed by or include the words “believes,” “estimates,” “expects,” “projects,” “forecasts,” “may,” “will,” “should,” “seeks,” “plans,” “scheduled,” “anticipates” or “intends” or similar expressions.

Forward-looking statements are not guarantees of performance. You should not put undue reliance on these statements which speak only as of the date hereof. You should understand that the following important factors, in addition to those discussed in “Risk Factors” and elsewhere in this Quarterly Report, could affect our future results and could cause those results or other outcomes to differ materially from those expressed or implied in our forward-looking statements:

 

    risks of the security and home automation industry, including risks of and publicity surrounding the sales, subscriber origination and retention process;

 

    the highly competitive nature of the security and home automation industry and product introductions and promotional activity by our competitors;

 

    litigation, complaints or adverse publicity;

 

    the impact of changes in consumer spending patterns, consumer preferences, local, regional, and national economic conditions, crime, weather, demographic trends and employee availability;

 

    adverse publicity and product liability claims;

 

    increases and/or decreases in utility and other energy costs, increased costs related to utility or governmental requirements; and

 

    cost increases or shortages in security and home automation technology products or components.

In addition, the origination and retention of new subscribers will depend on various factors, including, but not limited to, market availability, subscriber interest, the availability of suitable components, the negotiation of acceptable contract terms with subscribers, local permitting, licensing and regulatory compliance, and our ability to manage anticipated expansion and to hire, train and retain personnel, the financial viability of subscribers and general economic conditions.

These and other factors that could cause actual results to differ from those implied by the forward-looking statements in this Quarterly Report are more fully described in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 and elsewhere in this Quarterly Report on Form 10-Q. The risks described in “Risk Factors” are not exhaustive. Other sections of this Quarterly Report describe additional factors that could adversely affect our business, financial condition or results of operations. New risk factors emerge from time to time and it is not possible for us to predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing cautionary statements. We undertake no obligations to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

 

3


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

APX Group Holdings, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets (unaudited)

(In thousands)

 

     September 30,
2014
    December 31,
2013
 

ASSETS

    

Current Assets:

    

Cash and cash equivalents

   $ 67,186      $ 261,905   

Restricted cash and cash equivalents

     14,214        14,375   

Accounts receivable, net

     9,843        2,593   

Inventories, net

     61,273        29,260   

Prepaid expenses and other current assets

     40,808        13,870   
  

 

 

   

 

 

 

Total current assets

     193,324        322,003   

Property and equipment, net

     51,877        35,818   

Subscriber contract costs, net

     530,980        288,316   

Deferred financing costs, net

     54,602        59,375   

Intangible assets, net

     740,246        840,714   

Goodwill

     842,665        836,318   

Restricted cash and cash equivalents, net of current portion

     14,214        14,214   

Long-term investments and other assets, net

     9,874        27,676   
  

 

 

   

 

 

 

Total assets

   $ 2,437,782      $ 2,424,434   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current Liabilities:

    

Accounts payable

   $ 40,994      $ 24,004   

Accrued payroll and commissions

     103,535        46,007   

Accrued expenses and other current liabilities

     67,318        33,118   

Deferred revenue

     36,356        26,894   

Current portion of capital lease obligations

     4,309        4,199   
  

 

 

   

 

 

 

Total current liabilities

     252,512        134,222   

Notes payable, net

     1,863,413        1,762,049   

Capital lease obligations, net of current portion

     8,961        6,268   

Deferred revenue, net of current portion

     32,294        18,533   

Other long-term obligations

     9,121        3,905   

Deferred income tax liabilities

     9,884        9,214   
  

 

 

   

 

 

 

Total liabilities

     2,176,185        1,934,191   

Commitments and contingencies (See Note 13)

    

Stockholders’ equity:

    

Common stock

     —          —     

Additional paid-in capital

     603,851        652,488   

Accumulated deficit

     (327,630     (154,615

Accumulated other comprehensive loss

     (14,624     (7,630
  

 

 

   

 

 

 

Total stockholders’ equity

     261,597        490,243   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 2,437,782      $ 2,424,434   
  

 

 

   

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements

 

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Table of Contents

APX Group Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations (unaudited)

(In thousands)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2014     2013     2014     2013  

Revenues:

        

Monitoring revenue

   $ 140,227      $ 123,329      $ 393,383      $ 334,344   

Service and other sales revenue

     5,517        5,587        15,070        32,902   

Activation fees

     1,151        587        2,795        951   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     146,895        129,503        411,248        368,197   

Costs and expenses:

        

Operating expenses (exclusive of depreciation and amortization shown separately below)

     52,770        40,208        141,303        124,336   

Selling expenses

     26,884        26,488        81,202        75,394   

General and administrative expenses

     31,792        20,661        92,253        65,910   

Depreciation and amortization

     57,847        50,835        161,563        142,967   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

     169,293        138,192        476,321        408,607   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (22,398     (8,689     (65,073     (40,410

Other expenses (income):

        

Interest expense

     38,135        30,055        109,487        83,309   

Interest income

     (340     (411     (1,464     (1,087

Other expense (income), net

     535        (84     238        233   

Gain on 2GIG Sale

     —          (479     —          (47,122
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

     (60,728     (37,770     (173,334     (75,743

Income tax (benefit) expense

     (1,264     (2,865     (319     11,598   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (59,464   $ (34,905   $ (173,015   $ (87,341
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements

 

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Table of Contents

APX Group Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Loss (unaudited)

(In thousands)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2014     2013     2014     2013  

Net loss

   $ (59,464   $ (34,905   $ (173,015   $ (87,341

Other comprehensive (loss) income, net of tax effects:

        

Foreign currency translation adjustment

     (7,099     3,006        (6,994     (3,981
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive (loss) income

     (7,099     3,006        (6,994     (3,981
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (66,563   $ (31,899   $ (180,009   $ (91,322
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements

 

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Table of Contents

APX Group Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (unaudited)

(In thousands)

 

     Nine Months Ended
September 30,
 
     2014     2013  

Cash flows from operating activities:

    

Net loss

   $ (173,015   $ (87,341

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Amortization of subscriber contract costs

     40,320        12,815   

Amortization of customer relationships

     107,761        120,391   

Depreciation and amortization of other intangible assets

     13,482        9,760   

Amortization of deferred financing costs

     6,919        6,430   

Fire related asset losses

     3,039        —     

Loss on asset impairment

     1,351        —     

Gain on sale of 2GIG

     —          (47,122

Loss on sale or disposal of assets

     580        400   

Stock-based compensation

     1,363        1,317   

Provision for doubtful accounts

     11,237        8,299   

Paid-in-kind interest income

     (910     (1,050

Non-cash adjustments to deferred revenue

     155        1,075   

Deferred income taxes

     (540     8,592   

Changes in operating assets and liabilities, net of acquisitions and divestiture:

    

Accounts receivable

     (18,518     (9,741

Inventories

     (31,997     (15,782

Prepaid expenses and other current assets

     (4,077     6,085   

Accounts payable

     16,918        1,085   

Accrued expenses and other liabilities

     94,252        100,028   

Deferred revenue

     23,336        24,430   
  

 

 

   

 

 

 

Net cash provided by operating activities

     91,656        139,671   

Cash flows from investing activities:

    

Subscriber acquisition costs

     (284,912     (267,232

Capital expenditures

     (19,856     (5,788

Proceeds from the sale of 2GIG, net of cash sold

     —          144,750   

Acquisition of intangible assets

     (6,421     —     

Net cash used in acquisitions

     (18,500     (4,272

Investment in short-term investments—other

     (60,000     —     

Proceeds from short-term investments—other

     60,069        —     

Investment in preferred stock

     (3,000     —     

Other assets

     (92     (8,180
  

 

 

   

 

 

 

Net cash used in investing activities

     (332,712     (140,722

Cash flows from financing activities:

    

Proceeds from notes payable

     102,000        203,500   

Repayments of revolving line of credit

     —          (50,500

Borrowings from revolving line of credit

     —          22,500   

Proceeds from contract sales

     2,261        —     

Change in restricted cash

     161        —     

Repayments of capital lease obligations

     (4,528     (5,208

Deferred financing costs

     (2,782     (5,429

Payments of dividends

     (50,000     (60,000
  

 

 

   

 

 

 

Net cash provided by financing activities

     47,112        104,863   

Effect of exchange rate changes on cash

     (775     (169
  

 

 

   

 

 

 

Net (decrease) increase in cash

     (194,719     103,643   

Cash:

    

Beginning of period

     261,905        8,090   
  

 

 

   

 

 

 

End of period

   $ 67,186      $ 111,733   
  

 

 

   

 

 

 

Supplemental non-cash flow disclosure:

    

Capital lease additions

   $ 7,315      $ 2,988   

See accompanying notes to unaudited condensed consolidated financial statements

 

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Table of Contents

APX Group Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (unaudited)

NOTE 1—BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Unaudited Interim Financial Statements

The accompanying interim unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q have been prepared by APX Group Holdings, Inc. and subsidiaries (the “Company” or “APX”) without audit. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. The information as of December 31, 2013 included in the unaudited condensed consolidated balance sheets was derived from the Company’s audited consolidated financial statements. The unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q were prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments (all of which are considered of normal recurring nature) considered necessary to present fairly the Company’s financial position, results of operations and cash flows for the periods and dates presented. The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.

These unaudited condensed consolidated financial statements and notes should be read in conjunction with the Company’s audited consolidated financial statements and related notes for the years ended December 31, 2013 and 2012 set forth in the Company’s Annual Report on Form 10-K dated March 24, 2014, as filed with the Securities and Exchange Commission (“SEC”), which is available on the SEC’s website at sec.gov.

The direct-to-home component of the sales cycle for the Company is seasonal in nature. The summer sales season generally runs from late April to the end of August each year. The Company makes investments in the recruitment of the sales force and inventory prior to the summer sales season. The Company experiences increases in subscriber acquisition costs, as well as costs to support the sales force around North America, during the summer sales season.

Basis of Presentation—The unaudited condensed consolidated financial statements of the Company are presented for APX Group Holdings, Inc. and its wholly-owned subsidiaries. On April 1, 2013, the Company completed the sale of 2GIG Technologies, Inc. (“2GIG”) and its subsidiary to Nortek, Inc. (the “2GIG Sale”). Therefore, its results of operations are excluded following the sale and the results of operations prior to and subsequent to the 2GIG Sale are not necessarily comparable.

During the three months ended September 30, 2014, the Company recorded certain out-of-period adjustments totaling $3.8 million, primarily associated with equipment recorded as subscriber acquisition costs rather than operating expenses during the three months ended June 30, 2014 due to a reporting error identified during an information technology system implementation and included other immaterial items. As a result of these adjustments, subscriber acquisition costs decreased by $3.4 million and total operating expenses increased by $3.8 million.

Revenue Recognition—The Company recognizes revenue principally on three types of transactions: (i) monitoring, which includes revenues for monitoring and other automation services of the Company’s subscriber contracts and certain subscriber contracts that have been sold, (ii) service and other sales, which includes services provided on contracts, contract fulfillment revenue, sales of products that are not part of the basic equipment package and revenue from 2GIG, and (iii) activation fees on the Company’s contracts, which are amortized over the expected life of the customer.

Monitoring services for the Company’s subscriber contracts are billed in advance, generally monthly, pursuant to the terms of subscriber contracts and recognized ratably over the service period. Revenue from monitoring contracts that have been sold is recognized monthly as services are provided based on rates negotiated as part of the contract sales. Costs of providing ongoing monitoring services are expensed in the period incurred.

 

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Table of Contents

Service and other sales revenue is recognized as services are provided or when title to the products and equipment sold transfers to the customer. Contract fulfillment revenue, included in service and other sales, is recognized when payment is received from customers who cancel their contract in-term. Revenue from sales of products that are not part of the basic equipment package is recognized upon delivery of products.

Activation fees are generally charged to a customer when a new account is opened. This revenue is deferred and recognized using a 150% declining balance method over 12 years and converts to a straight-line methodology when the resulting revenue recognition is greater than that from the accelerated method for the remaining estimated life.

Through the date of the 2GIG Sale, service and other sales revenue included net recurring services revenue, which was based on back-end services, provided by Alarm.com, for all panels sold to distributors and direct-sell dealers and subsequently placed in service at end-user locations. The Company received a fixed monthly amount from Alarm.com for each system installed with non-Vivint customers that used the Alarm.com platform.

Revenue from the sale of subscriber contracts is recognized when ownership of the contracts has transferred to the purchaser. Any unamortized deferred revenue and costs related to contract sales are recognized at the time of the sale.

Subscriber Contract Costs—A portion of the direct costs of acquiring new subscribers, primarily sales commissions, equipment, and installation costs, are deferred and recognized over a pattern that reflects the estimated life of the subscriber relationships. The Company amortizes these costs over the estimated useful life by using a 150% declining balance method over 12 years and converts to a straight-line methodology when the resulting amortization charge is greater than that from the accelerated method for the remaining estimated life. The Company evaluates subscriber account attrition on a periodic basis, utilizing observed attrition rates for the Company’s subscriber contracts and industry information and, when necessary, makes adjustments to the estimated subscriber relationship period and amortization method.

Cash and Cash Equivalents—Cash and cash equivalents consists of highly liquid investments with remaining maturities when purchased of three months or less.

Restricted Cash and Cash Equivalents—Restricted cash and cash equivalents is restricted for a specific purpose and cannot be included in the general cash account. At September 30, 2014 and December 31, 2013, the restricted cash and cash equivalents was held by a third-party trustee. Restricted cash and cash equivalents consists of highly liquid investments with remaining maturities when purchased of three months or less.

Accounts Receivable—Accounts receivable consists primarily of amounts due from customers for recurring monthly monitoring services. The accounts receivable are recorded at invoiced amounts and are non-interest bearing. The gross amount of accounts receivable has been reduced by an allowance for doubtful accounts of $3.3 million and $1.9 million at September 30, 2014 and December 31, 2013, respectively. The Company estimates this allowance based on historical collection rates, subscriber attrition rates, and contractual obligations underlying the sale of the subscriber contracts to third parties. When the Company determines that there are accounts receivable that are uncollectible, they are charged off against the allowance for doubtful accounts. As of September 30, 2014 and December 31, 2013, no accounts receivable were classified as held for sale. Provision for doubtful accounts is included in general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations.

 

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The changes in the Company’s allowance for accounts receivable were as follows for the periods ended (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2014     2013     2014     2013  

Beginning balance

   $ 4,501      $ 2,625      $ 1,901      $ 2,301   

Provision for doubtful accounts

     4,017        2,860        11,275        8,299   

Write-offs and adjustments

     (5,236     (2,925     (9,894     (8,040
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 3,282      $ 2,560      $ 3,282      $ 2,560   
  

 

 

   

 

 

   

 

 

   

 

 

 

Inventories—Inventories, which comprise home automation and security system equipment and parts, are stated at the lower of cost or market with cost determined under the first-in, first-out (FIFO) method. The Company records an allowance for excess and obsolete inventory based on anticipated obsolescence, usage and historical write-offs.

Long-lived Assets and Intangibles—Property and equipment are stated at cost and depreciated on the straight-line method over the estimated useful lives of the assets or the lease term, whichever is shorter. Intangible assets with definite lives are amortized over the remaining estimated economic life of the underlying technology or relationships, which ranges from 2 to 10 years. Amortization expense associated with leased assets is included with depreciation expense. Routine repairs and maintenance are charged to expense as incurred. Definite-lived intangible assets are amortized on the straight-line method over the estimated useful life of the asset or in a pattern in which the economic benefits of the intangible asset are consumed. The Company periodically assesses potential impairment of its long-lived assets and intangibles and performs an impairment review whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In addition, the Company periodically assesses whether events or changes in circumstance continue to support an indefinite life of certain intangible assets or warrant a revision to the estimated useful life of definite-lived intangible assets.

Deferred Financing Costs—Costs incurred in connection with obtaining debt financing are deferred and amortized utilizing the straight-line method, which approximates the effective-interest method, over the life of the related financing. If such financing is paid off or replaced prior to maturity with debt instruments that have substantially different terms, the unamortized costs are charged to expense. Deferred financing costs included in the accompanying unaudited condensed consolidated balance sheets at September 30, 2014 and December 31, 2013 were $54.6 million and $59.4 million, net of accumulated amortization of $17.4 million and $9.9 million, respectively. Amortization expense on deferred financing costs recognized and included in interest expense in the accompanying unaudited condensed consolidated statements of operations, totaled $2.6 million and $2.3 million for the three months ended September 30, 2014 and 2013, respectively and $7.6 million and $6.5 million for the nine months ended September 30, 2014 and 2013, respectively.

Residual Income Plan—The Company has a program that allows third-party sales channel partners to receive additional compensation based on the performance of the underlying contracts they create. The Company calculates the present value of the expected future payments and recognizes this amount in the period the commissions are earned. Subsequent accretion and adjustments to the estimated liability are recorded as interest and other expense, respectively. The Company monitors actual payments and customer attrition on a periodic basis and, when necessary, makes adjustments to the liability. The amount included in accrued expenses and other current liabilities was $0.4 million and $0.3 million as of September 30, 2014 and December 31, 2013, respectively, and the amount included in other long-term obligations was $2.7 million and $2.4 million at September 30, 2014 and December 31, 2013, respectively, representing the present value of the estimated amounts owed to third-party sales channel partners.

Stock-Based Compensation—The Company measures compensation cost based on the grant-date fair value of the award and recognizes that cost over the requisite service period of the awards (See Note 12).

Income Taxes—The Company accounts for income taxes based on the asset and liability method. Under the asset and liability method, deferred tax assets and deferred tax liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and

 

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liabilities and their respective tax bases and operating loss and tax credit carryforwards. Valuation allowances are established when necessary to reduce deferred tax assets when it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized.

The Company recognizes the effect of an uncertain income tax position on the income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. The Company’s policy for recording interest and penalties is to record such items as a component of the provision for income taxes.

Liability—Contracts Sold—On March 31, 2014, the Company received approximately $2.3 million in proceeds from the sale of certain subscriber contracts to a third-party. Concurrently, the Company entered into an agreement with the buyer to continue providing billing, monitoring and support services for the contracts that were sold for a period of ten years. As a result of this continuing involvement on the part of the Company in the servicing of the contracts, accounting guidance precluded gain recognition at the time of the sale. Accordingly, the Company has treated this transaction as a secured borrowing and recorded a liability for the proceeds received at the time of the sale. The amount included in accrued expenses and other current liabilities related to this liability was $2.1 million as of September 30, 2014. These amounts are being amortized using the effective interest method over twelve years, the expected term of these subscriber contracts.

Use of Estimates—The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates.

Concentrations of Credit Risk—Financial instruments that potentially subject the Company to concentration of credit risk consist principally of receivables and cash. At times during the year, the Company maintains cash balances in excess of insured limits. The Company is not dependent on any single customer or geographic location. The loss of a customer would not adversely impact the Company’s operating results or financial position.

Concentrations of Supply Risk—As of September 30, 2014, approximately 75% of the Company’s installed panels were 2GIG Go!Control panels and 17% were SkyControl panels. On April 1, 2013, the Company completed the 2GIG Sale. In connection with the 2GIG Sale, the Company entered into a five-year supply agreement with 2GIG, pursuant to which they will be the exclusive provider of the Company’s control panel requirements, subject to certain exceptions as provided in the supply agreement. The loss of 2GIG as a supplier could potentially impact the Company’s operating results or financial position.

Fair Value Measurement—Fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Assets and liabilities subject to on-going fair value measurement are categorized and disclosed into one of three categories depending on observable or unobservable inputs employed in the measurement. These two types of inputs have created the following fair value hierarchy:

Level 1: Quoted prices in active markets that are accessible at the measurement date for assets and liabilities.

Level 2: Observable prices that are based on inputs not quoted in active markets, but corroborated by market data.

Level 3: Unobservable inputs are used when little or no market data is available.

This hierarchy requires the Company to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value. The Company recognizes transfers between levels of the hierarchy based on the fair values of the respective financial measurements at the end of the reporting period in which the transfer occurred. There were no transfers between levels of the fair value hierarchy during the nine months ended September 30, 2014 and the fiscal year 2013.

 

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The carrying amounts of the Company’s accounts receivable, accounts payable and accrued and other liabilities approximate their fair values due to their short maturities.

Goodwill—The Company conducts a goodwill impairment analysis annually and as necessary if changes in facts and circumstances indicate that the fair value of the Company’s reporting units may be less than its carrying amount. When indicators of impairment do not exist and certain accounting criteria are met, the Company is able to evaluate goodwill impairment using a qualitative approach. When necessary, the Company’s quantitative goodwill impairment test consists of two steps. The first step requires that the Company compare the estimated fair value of its reporting units to the carrying value of the reporting unit’s net assets, including goodwill. If the fair value of the reporting unit is greater than the carrying value of its net assets, goodwill is not considered to be impaired and no further testing is required. If the fair value of the reporting unit is less than the carrying value of its net assets, the Company would be required to complete the second step of the test by analyzing the fair value of its goodwill. If the carrying value of the goodwill exceeds its fair value, an impairment charge is recorded.

Foreign Currency Translation and Other Comprehensive Income—The functional currencies of Vivint Canada, Inc. and Vivint New Zealand, Ltd. are the Canadian and New Zealand dollars, respectively. Accordingly, assets and liabilities are translated from their respective functional currencies into U.S. dollars at period-end rates and revenue and expenses are translated at the weighted-average exchange rates for the period. Adjustments resulting from this translation process are classified as other comprehensive income (loss) and shown as a separate component of equity.

Letters of Credit—As of September 30, 2014 and December 31, 2013, the Company had $3.0 million and $2.2 million, respectively, of letters of credit issued in the ordinary course of business, all of which are undrawn.

New Accounting Pronouncement—In May 2014, the FASB issued authoritative guidance which clarifies the principles used to recognize revenue for all entities. The new guidance requires companies to recognize revenue when it transfers goods or services to a customer in an amount that reflects the consideration to which a company expects to be entitled. The guidance is effective for annual and interim periods beginning after December 15, 2016. The guidance allows for either a “full retrospective” adoption or a “modified retrospective” adoption, however early adoption is not permitted. The Company is currently evaluating the impact the adoption of this guidance will have on our consolidated financial statements.

In February 2013, the FASB issued authoritative guidance which expands the disclosure requirements for amounts reclassified out of accumulated other comprehensive income (“AOCI”). The guidance requires an entity to provide information about the amounts reclassified out of AOCI by component and present, either on the face of the income statement or in the notes to financial statements, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. This guidance does not change the current requirements for reporting net income or OCI in financial statements. The guidance became effective for us in the first quarter of fiscal year 2014. The adoption of this guidance did not have a material impact on our financial position, results of operations or cash flows.

In July 2013, the FASB issued authoritative guidance which amends the guidance related to the presentation of unrecognized tax benefits and allows for the reduction of a deferred tax asset for a net operating loss carryforward whenever the net operating loss carryforward or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. This guidance became effective for us for annual and interim periods beginning in fiscal year 2014. The adoption of this guidance did not have a material impact on our financial position, results of operations or cash flows.

 

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NOTE 2—BUSINESS COMBINATIONS

Space Monkey Acquisition

On September 10, 2014, a wholly-owned subsidiary of the Company merged with Space Monkey, Inc. (“Space Monkey”), a data cloud storage technology company. Pursuant to the terms of the merger the Company paid aggregate cash consideration of $15.0 million, of which $1.5 million is held in escrow for indemnification obligations and is required to be released no later than December 31, 2014. This strategic acquisition was made to support the growth and development of the Company’s smart home platform. The accompanying condensed consolidated financial statements include the financial position and results of operations associated with the Space Monkey assets acquired and liabilities assumed from September 10, 2014. The pro forma impact of Space Monkey on the Company’s financial position and results of operations for the three and nine months ended September 30, 2014 is immaterial.

The determination of the final purchase price is subject to potential adjustments, primarily related to the valuation of certain intangible assets and income taxes. The following table summarizes the preliminary estimated fair value of the assets acquired and liabilities assumed at the time of acquisition (in thousands):

 

Net assets acquired from Space Monkey

   $ 404   

Deferred tax liability

     (1,106

Intangible assets (See Note 9)

     8,300   

Goodwill

     7,402   
  

 

 

 

Total estimated fair value of the assets acquired and liabilities assumed

   $ 15,000   
  

 

 

 

During the three and nine months ended September 30, 2014, the Company incurred costs associated with the Space Monkey acquisition, which were not material, consisting of accounting, legal and professional fees and payments to employees directly associated with the acquisition. These costs are included in general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations.

Wildfire Acquisition

On January 31, 2014, a wholly-owned subsidiary of the Company completed the purchase of certain assets, and assumed certain liabilities, of Wildfire Broadband, LLC (“Wildfire”). Pursuant to the terms of the asset purchase agreement the Company paid aggregate cash consideration of $3.5 million, of which $0.4 million is held in escrow for indemnification obligations and is required to be released no later than January 31, 2015. This strategic acquisition was made to provide the Company access to Wildfire’s existing customers, wireless internet infrastructure and know-how. The accompanying condensed consolidated financial statements include the financial position and results of operations associated with the Wildfire assets acquired and liabilities assumed from January 31, 2014. The pro forma impact of Wildfire on the Company’s financial position and results of operations for the three and nine months ended September 30, 2014 is immaterial. The associated goodwill is deductible for income tax purposes.

The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the time of acquisition (in thousands):

 

Net assets acquired from Wildfire

   $ 96  

Intangible assets (See Note 9)

     2,900  

Goodwill

     504  
  

 

 

 

Total cash consideration

     3,500  

Estimated net working capital adjustment

     (61 )
  

 

 

 

Total fair value of the assets acquired and liabilities assumed

   $ 3,439  
  

 

 

 

 

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During the nine months ended September 30, 2014, the Company incurred costs associated with the Wildfire acquisition, which were not material, consisting of accounting, legal and professional fees and payments to employees directly associated with the acquisition. These costs are included in general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations.

In addition, during the three months ended September 30, 2014, the Company made a cost-based investment in a privately-held company (the “Investee”). The amount of the investment by the Company in the Investee was $0.3 million as of September 30, 2014. The Company could make up to $2.7 million in additional investments in the Investee, subject to the achievement of certain technology development milestones. These additional investments are expected to occur through July 1, 2016.

NOTE 3—DIVESTITURE OF SUBSIDIARY

On April 1, 2013, the Company completed the 2GIG Sale. Pursuant to the terms of the 2GIG Sale, Nortek, Inc. acquired all of the outstanding common stock of 2GIG for aggregate cash consideration of approximately $148.9 million, including cash, working capital and indebtedness adjustments as provided in the stock purchase agreement. In connection with the 2GIG Sale, the Company entered into a five-year supply agreement with 2GIG, pursuant to which they will be the exclusive provider of the Company’s control panel requirements, subject to certain exceptions as provided in the supply agreement. A portion of the net proceeds from the 2GIG Sale was used to repay $44.0 million of outstanding borrowings under the Company’s revolving credit facility. The terms of the indenture governing the existing senior unsecured notes, the indenture governing the existing senior secured notes and the credit agreement governing the revolving credit facility, permit the Company, subject to certain conditions, to distribute all or a portion of the net proceeds from the 2GIG Sale to the Company’s stockholders. In May 2013, the Company distributed a dividend of $60.0 million from such proceeds to stockholders. Subject to the applicable conditions, the Company may distribute the remaining proceeds in the future. The Company’s financial position and results of operations include 2GIG through March 31, 2013.

The following table summarizes the net gain recognized in connection with this divestiture (in thousands):

 

Adjusted net sale price

   $ 148,871   

2GIG assets (including cash of $3,383), net of liabilities

     (109,053

2.0 technology, net of amortization

     16,903   

Other

     (9,855
  

 

 

 

Net gain on divestiture

   $ 46,866   
  

 

 

 

NOTE 4—VARIABLE INTEREST ENTITY

Accounting rules require the primary beneficiary of a variable interest entity (“VIE”) to include the financial position and results of operations of the VIE in its condensed consolidated financial statements. Vivint Solar, Inc. (“Solar”), formed by the Company in April 2011, installs solar panels on the roofs of customers’ homes and enters into agreements for customers to purchase the electricity generated by the panels. Solar also takes advantage of local government and federal incentive programs that offer assistance in generating green power. Solar was consolidated as a VIE by APX Group, Inc. from April 2011 through November 15, 2012. On November 16, 2012, an investor group comprised of certain investment funds affiliated with Blackstone Capital Partners VI L.P., and certain co-investors and management investors (collectively, the “Investors”) purchased Solar for $75.0 million and became its primary beneficiary and, as a result, the Solar financial position and results of operations are not consolidated by the Company subsequent to November 16, 2012. The assets of Solar are restricted in that they are only available to settle the obligations of Solar and not of the Company and similarly, the creditors of Solar have no recourse to the general assets of the Company.

The Company and Solar have entered into an agreement under which the Company subleases corporate office space, and provides certain other administrative services, to Solar. During the three months ended September 30, 2014 and 2013, the Company charged $2.3 million and $0.3 million, respectively, and during the nine months ended September 30, 2014 and 2013, the Company charged $5.9 million and $0.8 million, respectively, of general and administrative expenses to Solar in connection with this agreement. The balance due from Solar in connection with this agreement and other expenses paid on Solar’s behalf was $3.1 million at December 31, 2013 and is

 

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included in prepaid expenses and other current assets in the accompanying unaudited condensed consolidated balance sheets. The balance due from Solar in connection with this agreement at September 30, 2014 was immaterial.

On December 27, 2012, the Company executed a Subordinated Note and Loan Agreement with Solar. The terms of the agreement state that Solar may borrow up to $20.0 million, bearing interest on the outstanding balance at an annual rate of 7.5%, which interest is due and payable semi-annually on June 1 and December 1 of each year commencing on June 1, 2013. The balance outstanding on September 30, 2014, representing principal of $20.0 million and payment-in-kind interest of $2.2 million, and on December 31, 2013, representing principal of $20.0 million and payment-in-kind interest of $1.3 million, is included in prepaid and other current assets and long-term investments and other assets, net, respectively, in the accompanying unaudited condensed consolidated balance sheets. In addition, accrued interest of $0.5 million and $0.1 million on September 30, 2014 and December 31, 2013, respectively, is included in prepaid expenses and other current assets in the accompanying unaudited condensed consolidated balance sheets. These variable interests represent the Company’s maximum exposure to loss from direct involvement with Solar.

NOTE 5—LONG-TERM DEBT

On November 16, 2012, APX issued $1.3 billion aggregate principal amount of notes, of which $925.0 million aggregate principal amount of 6.375% senior secured notes due 2019 (the “outstanding 2019 notes”) mature on December 1, 2019 and are secured on a first-priority lien basis by substantially all of the tangible and intangible assets whether now owned or hereafter acquired by the Company, subject to permitted liens and exceptions, and $380.0 million aggregate principal amount of 8.75% senior notes due 2020 (the “outstanding 2020 notes” and together with the outstanding 2019 notes, the “notes”), mature on December 1, 2020.

During 2013, the Company completed two offerings of additional 8.75% senior notes due 2020 under the indenture dated November 16, 2012 (the “2020 notes”). On May 31, 2013, the Company issued $200.0 million of 2020 notes at a price of 101.75% and on December 13, 2013, the Company issued an additional $250.0 million of 2020 notes at a price of 101.50%. Blackstone Advisory Partners L.P. (“Blackstone Partners”) participated as one of the initial purchasers of the 2020 notes in each of the May 31, 2013 and December 31, 2013 offerings and received approximately $0.2 million and $0.2 million in fees, respectively, at the time of closing.

On July 1, 2014, the Company issued an additional $100.0 million of 2020 notes. In connection with the issuance, Blackstone Partners participated as one of the initial purchasers of the 2020 notes and received approximately $0.1 million in fees at the time of closing.

Interest on the notes accrues at the rate of 6.375% per annum for the outstanding 2019 notes and 8.75% per annum for the outstanding 2020 notes. Interest on the notes is payable semiannually in arrears on each June 1 and December 1. The Company may redeem each series of the notes, in whole or part, at any time at a redemption price equal to the principal amount of the notes to be redeemed, plus a make-whole premium and any accrued and unpaid interest at the redemption date. In addition, APX may redeem the notes at the prices and on the terms specified in the applicable indenture.

In connection with each issuance of the notes, the Company entered into Exchange and Registration Rights Agreements (each a “Registration Rights Agreement”) with the initial purchasers of the notes, dated November 16, 2012, May 8, 2013, December 13, 2013 and July 1, 2014, respectively.

In connection with the issuance of the initial notes on November 16, 2012 and the subsequent offering on May 31, 2013, in accordance with the applicable Registration Rights Agreements, the Company filed a registration statement on Form S-4 with the Securities and Exchange Commission with respect to an exchange offer to exchange the notes of each series for an issue of Notes (except the Exchange Notes do not contain transfer restrictions). The exchange offer was completed on October 29, 2013.

In connection with the issuance of the subsequent offering on December 13, 2013, under the applicable Registration Rights Agreement, the Company filed a registration statement on Form S-4 with the Securities and

 

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Exchange Commission with respect to an exchange offer to exchange the Notes of each series for an issue of Notes (except the Exchange Notes do not contain transfer restrictions). This exchange offer was completed on March 7, 2014.

Revolving Credit Facility

On November 16, 2012, APX, the Company and the other guarantors entered into a revolving credit facility in the aggregate principal amount of $200.0 million. On June 28, 2013, the Company amended and restated the credit agreement to provide for a new repriced tranche of revolving credit commitments with a lower interest rate. Nearly all of the existing tranches of revolving credit commitments were terminated and converted into the repriced tranche, with the unterminated portion of the existing tranche continuing to accrue interest at the original rate.

Borrowings under the revolving credit facility bear interest at a rate per annum equal to an applicable margin plus, at our option, either (1) the base rate determined by reference to the highest of (a) the Federal Funds rate plus 0.50%, (b) the prime rate of Bank of America, N.A. and (c) the LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month, plus 1.00% or (2) the LIBOR rate determined by reference to the London interbank offered rate for dollars for the interest period relevant to such borrowing. The applicable margin for base rate-based borrowings (1)(a) under the repriced tranche is currently 2.0% per annum and (b) under the former tranche is currently 3.0% and (2)(a) the applicable margin for LIBOR rate-based borrowings (a) under the repriced tranche is currently 3.0% per annum and (b) under the former tranche is currently 4.0%. The applicable margin for borrowings under the revolving credit facility is subject to one step-down of 25 basis points based on the Company’s consolidated first lien net leverage ratio at the end of each fiscal quarter, commencing with delivery of its consolidated financial statements for the first full fiscal quarter ending after the closing date.

In addition to paying interest on outstanding principal under the revolving credit facility, the Company is required to pay a quarterly commitment fee of 0.50% (which will be subject to one step-down based on our consolidated first lien net leverage ratio) to the lenders under the revolving credit facility in respect of the unutilized commitments thereunder. The Company also pays customary letter of credit and agency fees. The borrowings are due November 16, 2017, which may be repaid at any time without penalty.

The Company’s outstanding debt at September 30, 2014 had maturity dates of 2019 and beyond and consisted of the following (in thousands):

 

     Outstanding
Principal
     Unamortized
Premium
     Net Carrying
Amount
 

Revolving credit facility

   $ —         $ —         $ —     

6.375% Senior Secured Notes due 2019

     925,000         —           925,000   

8.75% Senior Notes due 2020

     930,000         8,413         938,413   
  

 

 

    

 

 

    

 

 

 

Total Notes payable

   $ 1,855,000       $ 8,413       $ 1,863,413   
  

 

 

    

 

 

    

 

 

 

The Company’s outstanding debt at December 31, 2013 consisted of the following (in thousands):

 

     Outstanding
Principal
     Unamortized
Premium
     Net Carrying
Amount
 

Revolving credit facility

   $ —         $ —         $ —     

6.375% Senior Secured Notes due 2019

     925,000         —           925,000   

8.75% Senior Notes due 2020

     830,000         7,049         837,049   
  

 

 

    

 

 

    

 

 

 

Total Notes payable

   $ 1,755,000       $ 7,049       $ 1,762,049   
  

 

 

    

 

 

    

 

 

 

 

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NOTE 6—BALANCE SHEET COMPONENTS

The following table presents balance sheet component balances (in thousands):

 

     September 30,
2014
    December 31,
2013
 

Subscriber contract costs

    

Subscriber contract costs

   $ 593,454      $ 310,666  

Accumulated amortization

     (62,474     (22,350 )
  

 

 

   

 

 

 

Subscriber contract costs, net

   $ 530,980      $ 288,316  
  

 

 

   

 

 

 

Long-term investments and other assets

    

Notes receivable from related parties, net of allowance (See Notes 4 and 18)

   $ 296      $ 21,323  

Security deposit receivable

     6,131        6,261  

Other

     3,447        92  
  

 

 

   

 

 

 

Total long-term investments and other assets, net

   $ 9,874      $ 27,676  
  

 

 

   

 

 

 

Accrued payroll and commissions

    

Accrued payroll

   $ 16,866      $ 15,475  

Accrued commissions

     86,669        30,532  
  

 

 

   

 

 

 

Total accrued payroll and commissions

   $ 103,535      $ 46,007  
  

 

 

   

 

 

 

Accrued expenses and other current liabilities

    

Accrued interest payable

   $ 46,781      $ 10,982  

Loss contingencies

     7,639        9,263  

Other

     12,898        12,873  
  

 

 

   

 

 

 

Total accrued expenses and other current liabilities

   $ 67,318      $ 33,118  
  

 

 

   

 

 

 

 

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NOTE 7—PROPERTY AND EQUIPMENT

Property and equipment consisted of the following (in thousands):

 

     September 30,
2014
    December 31,
2013
    Estimated
Useful Lives

Vehicles

   $ 17,990      $ 13,851      3 - 5 years

Computer equipment and software

     15,863        6,742      3 - 5 years

Leasehold improvements

     11,885        13,345      2 - 15 years

Office furniture, fixtures and equipment

     8,472        4,793      7 years

Warehouse equipment

     111        1,802      7 years

Buildings

     702        702      39 years

Construction in process

     10,732        3,119     
  

 

 

   

 

 

   
     65,755        44,354     

Accumulated depreciation and amortization

     (13,878     (8,536  
  

 

 

   

 

 

   

Net property and equipment

   $ 51,877      $ 35,818     
  

 

 

   

 

 

   

Property and equipment includes approximately $18.1 million and $13.7 million of assets under capital lease obligations, net of accumulated amortization of $4.3 million and $2.7 million at September 30, 2014 and December 31, 2013, respectively. Depreciation and amortization expense on all property and equipment was $2.8 million and $2.2 million for the three months ended September 30, 2014 and 2013, respectively and $7.9 million and $6.7 million for the nine months ended September 30, 2014 and 2013, respectively. Amortization expense relates to assets under capital leases and is included in depreciation and amortization expense.

NOTE 8—INTANGIBLE ASSETS

The following table presents intangible asset balances (in thousands):

 

     September 30,
2014
    December 31,
2013
    Estimated
Useful Lives

Definite-lived intangible assets:

      

Customer contracts

   $ 982,045      $ 984,403      10 years

2.0 technology

     17,000        17,000      8 years

Acquired technologies

     11,140        4,040      3 - 6 years

Patents

     6,207        —        5 years

Skypanel technology

     3,813        3,814      3 years

Non-compete agreements

     2,000        —        2 - 3 years

Other intellectual property

     650        650      2 years

CMS technology

     337        2,300      1 year
  

 

 

   

 

 

   
     1,023,192        1,012,207     

Accumulated amortization

     (283,219     (171,493  
  

 

 

   

 

 

   

Definite-lived intangible assets, net

     739,973        840,714     

Indefinite-lived intangible assets:

      

IP addresses

     214        —       

Domain names

     59        —       
  

 

 

   

 

 

   

Total Indefinite-lived intangible assets

     273        —       
  

 

 

   

 

 

   

Total intangible assets, net

   $ 740,246      $ 840,714     
  

 

 

   

 

 

   

Identifiable intangible assets acquired by the Company in connection with the Wildfire acquisition were $2.1 million of customer contracts and $0.8 million associated with non-compete agreements entered into by certain former members of Wildfire management. Identifiable intangible assets acquired by the Company in connection with the Space Monkey acquisition were $7.1 million of Space Monkey technology and $1.2 million associated with non-compete agreements entered into by certain former members of Space Monkey management. In addition, during the nine months ended September 30, 2014, the Company acquired $6.5 million of other intangible assets related to patents, domain names and Internet Protocol (“IP”) addresses.

 

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On March 29, 2014, the Company implemented new customer relationship management software (“CRM”). Historically, the Company’s customer management system (“CMS”) technology was used for customer support and inventory tracking. The new CRM software replaced the customer support functionality of the CMS technology. Following the CRM implementation, the CMS technology continued to be used for inventory tracking. Due to the implementation of the new CRM software, as of March 31, 2014, the Company determined there to be a significant change in the extent and manner in which the CMS technology was being used. The Company estimated the fair value of the CMS technology as of March 31, 2014 to be $0.3 million based on management experience, inquiry and assessment of the remaining functionality of this technology as it related to inventory tracking. The associated impairment loss of $1.4 million is included in operating expenses in the accompanying unaudited condensed consolidated statement of operations for the nine months ended September 30, 2014. In addition, the estimated remaining useful life of the CMS technology was evaluated and revised to one year from March 31, 2014, based on the intended use of the asset. The impact on income from continuing operations and net income from the change in the estimated remaining useful life was immaterial.

Amortization expense related to intangible assets was approximately $38.0 million and $40.7 million for the three months ended September 30, 2014 and 2013, respectively. Amortization expense related to intangible assets was approximately $113.3 million and $123.4 million for the nine months ended September 30, 2014 and 2013, respectively.

Estimated future amortization expense of intangible assets, excluding patents currently in process, is as follows as of September 30, 2014 (in thousands):

 

2014—remaining period

   $ 38,010   

2015

     136,093   

2016

     118,480   

2017

     102,113   

2018

     90,342   

Thereafter

     254,767   

Future amortization associated with patents currently in process

     168   
  

 

 

 

Total estimated amortization expense

   $ 739,973   
  

 

 

 

 

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NOTE 9—FAIR VALUE MEASUREMENTS

Cash equivalents and restricted cash equivalents are classified as Level 1 as they have readily available market prices in an active market. The preferred stock, as defined below, is classified as Level 3 and is valued using its cost basis, which approximates fair value. The following summarizes the financial instruments of the Company at fair value based on the valuation approach applied to each class of security as of September 30, 2014 and December 31, 2013 (in thousands):

 

     Fair Value Measurement at Reporting Date Using  
     Balance at
September 30,
2014
     Quoted Prices
in Active
Markets for
Identical
Assets

(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Assets:

           

Cash equivalents:

           

Money market funds

   $ 10,013       $ 10,013       $ —         $ —     

Restricted cash equivalents:

           

Money market funds

     14,214         14,214         —           —     

Restricted cash equivalents, net of current portion:

           

Money market funds

     14,214         14,214         —           —     

Long-term investments and other assets, net

           

Preferred stock

     3,000         —           —           3,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 41,441       $ 38,441       $ —         $ 3,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Fair Value Measurement at Reporting Date Using  
     Balance at
December 31,
2013
     Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Assets:

           

Cash equivalents:

           

Money market funds

   $ 10,002       $ 10,002       $ —         $ —     

Restricted cash equivalents:

           

Money market funds

     14,214         14,214         —           —     

Restricted cash equivalents, net of current portion:

           

Money market funds

     14,214         14,214         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 38,430       $ 38,430       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

The carrying amounts of the Company’s accounts receivable, accounts payable and accrued and other liabilities approximate their fair values due to their short maturities.

On February 19, 2014, the Company invested $3.0 million in a convertible note (“Convertible Note”) of a privately held company (“Investee”) not affiliated with the Company. The Convertible Note had a stated maturity date of February 19, 2015 and bore interest equal to the greater of (a) 0.5% or (b) annual interest rates established for federal income tax purposes by the Internal Revenue Service. The outstanding principal and accrued interest balance of the Convertible Note converted to preferred stock (“preferred stock”) of the Investee on August 29, 2014, under the terms of the agreement. The preferred stock has been classified as available-for-sale and measured at fair value in accordance with ASC 320, Investments—Debt and Equity Securities, with remeasurement occurring at the end of each reporting period and any changes in fair value included in other comprehensive income. As of September 30, 2014, the estimated aggregate fair value of the preferred stock was equal to its cost of $3.0 million and was considered a Level 3 measurement and is included in long-term investments and other assets, net in the accompanying unaudited condensed consolidated balance sheet as of September 30, 2014. There were no gains or losses recognized for the nine months ended September 30, 2014 associated with this investment.

The fair market value of the Company’s Senior Secured Notes was approximately $898.4 million and $941.2 million as of September 30, 2014 and December 31, 2013, respectively. The carrying value of the Company’s Senior Secured Notes was $925.0 million as of September 30, 2014 and December 31, 2013. The Company’s Senior Notes had a fair market value of approximately $846.3 million and $844.5 million as of September 30, 2014 and December 31, 2013, respectively, and a carrying

amount of $930.0 million and $830.0 million as of September 30, 2014 and December 31, 2013, respectively. The fair value of the

Senior Secured Notes and the Senior Notes was considered a Level 2 measurement as the value was determined using observable market inputs, such as current interest rates as well as prices observable from less active markets.

In connection with the Wildfire acquisition, the fair value of intangible assets was considered a Level 3 measurement and was determined using the income and market approach. Key assumptions used in the determination of the fair value include estimated earnings and discount rates between 12% and 20%.

 

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In connection with the Space Monkey acquisition, the fair value of intangible assets was considered a Level 3 measurement and was determined using the income approach. Key assumptions used in the determination of the fair value include an internal rate of return and a weighted average cost of capital of 25% and 20%, respectively.

NOTE 10—FACILITY FIRE

On March 18, 2014, a fire occurred at a facility leased by the company in Lindon, Utah. This facility contained the Company’s primary inventory warehouse and call center operations. For the three and nine months ended September 30, 2014, the Company recognized gross expenses of $1.4 million and $7.1 million, less probable insurance recoveries of $3.2 million and $6.2 million, respectively, related to the fire damage. These expenses and probable insurance recoveries are included in general and administrative costs on the unaudited condensed consolidated statements of operations. Of the $6.2 million in probable insurance recoveries, $2.8 million were received by the Company prior to September 30, 2014. The expenses associated with the fire primarily related to impairment of damaged assets and recovery costs to maintain business continuity. The Company is seeking additional insurance recoveries and will recognize those when receipt becomes probable. The $3.5 million of probable insurance recoveries not yet received from the Company’s insurance provider are included in prepaid expenses and other current assets in the accompanying unaudited condensed consolidated balance sheet at September 30, 2014.

NOTE 11—INCOME TAXES

In order to determine the quarterly provision (benefit) for income taxes, the Company uses an estimated annual effective tax rate, which is based on expected annual income and statutory tax rates in the various jurisdictions in which the Company operates. Certain significant or unusual items are separately recognized in the quarter during which they occur and can be a source of variability in the effective tax rates from quarter to quarter.

The Company’s effective income tax rate for the nine months ended September 30, 2014 was approximately 0.19%. In computing income tax expense (benefit), the Company estimates its annual effective income tax rate jurisdiction by jurisdiction and entity by entity for which tax attributes must be separately considered for the calendar year ending December 31, 2014, excluding discrete items. Each jurisdictional or entity estimated annual tax rate is applied to actual year-to-date pre-tax book income (loss) of each jurisdiction or entity. Both the 2014 and 2013 effective tax rates are less than the statutory rate due to the combination of not recognizing benefit for expected pre-tax losses of the US jurisdiction, recognizing current state income tax expense for minimum state taxes and the reduction of the valuation allowance as a result of the Space Monkey acquisition.

For 2014, the Company expects to realize a loss before income taxes and expects to record a full valuation allowance against the net deferred tax assets of the consolidated group within the US, Canadian and New Zealand jurisdictions. The Company has recorded tax expense for state and local taxes. A valuation allowance is required when there is significant uncertainty as to the ability to realize the deferred tax assets. Because the realization of the deferred tax assets related to the Company’s net operating losses (NOLs) is dependent upon future income related to domestic and foreign jurisdictional operations that have historically generated losses, management determined that the Company continues to not meet the “more likely than not” threshold that those NOLs will be realized. Accordingly, a valuation allowance is required. A similar history of losses is present in the Company’s Canadian and New Zealand jurisdictions. However, as of September 30, 2014, the deferred tax assets related to the Company’s Canadian and New Zealand jurisdictions’ NOLs are offset by existing deferred income tax liabilities resulting in a net deferred tax liability position in both jurisdictions.

 

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NOTE 12—STOCK-BASED COMPENSATION

313 Incentive Units

The Company’s indirect parent, 313 Acquisition LLC (“313”), which is wholly owned by the Investors, has authorized the award of profits interests, representing the right to share a portion of the value appreciation on the initial capital contributions to 313 (“Incentive Units”). As of September 30, 2014, a total of 75,181,252 Incentive Units had been awarded to current and former members of senior management and a board member, of which 46,484,562 were issued to the Company’s Chief Executive Officer and President. The Incentive Units are subject to time-based and performance-based vesting conditions, with one-third subject to ratable time-based vesting over a five year period and two-thirds subject to the achievement of certain investment return thresholds by The Blackstone Group, L.P. and its affiliates (“Blackstone”). The Company anticipates making comparable equity incentive grants at 313 to other members of senior management and adopting other equity and cash-based incentive programs for other members of management from time to time. The fair value of stock-based awards is measured at the grant date and is recognized as expense over the employee’s requisite service period. The grant date fair value was determined using a Monte Carlo simulation valuation approach with the following assumptions: expected volatility of 55% to 65%; expected exercise term from 4 to 5 years; and risk-free rate of 0.62% to 1.18%.

Vivint Stock Appreciation Rights

The Company’s subsidiary, Vivint, has awarded Stock Appreciation Rights (“SARs”) to various levels of key employees. The purpose of the SARs is to attract and retain personnel and provide an opportunity to acquire an equity interest of Vivint. The SARs are subject to time-based and performance-based vesting conditions, with one-third subject to ratable time-based vesting over a five year period and two-thirds subject to the achievement of certain investment return thresholds by Blackstone. In connection with this plan, 7,296,250 SARs were outstanding as of September 30, 2014. In addition, 36,065,303 SARs have been set aside for funding incentive compensation pools pursuant to long-term incentive plans established by the Company.

The fair value of the Vivint awards is measured at the grant date and is recognized as expense over the employee’s requisite service period. The fair value is determined using a Black-Scholes option valuation model with the following assumptions: expected volatility varies from 55% to 60%, expected dividends of 0%; expected exercise term between 6.01 and 6.50 years; and risk-free rates between 1.72% and 1.77%. Due to the lack of historical exercise data, the Company used the simplified method in determining the estimated exercise term, for all Vivint awards.

Wireless Stock Appreciation Rights

The Company’s subsidiary, Vivint Wireless, has awarded SARs to various key employees. The purpose of the SARs is to attract and retain personnel and provide an opportunity to acquire an equity interest of Vivint Wireless. The SARs are subject to a five year time-based ratable vesting period. In connection with this plan, 70,000 SARs were outstanding as of September 30, 2014. The Company anticipates making similar grants from time to time.

The fair value of the Vivint Wireless awards is measured at the grant date and is recognized as expense over the employee’s requisite service period. The fair value is determined using a Black-Scholes option valuation model with the following assumptions: expected volatility of 65%, expected dividends of 0%; expected exercise term of 6.50 years; and risk-free rate of 1.51%. Due to the lack of historical exercise data, the Company used the simplified method in determining the estimated exercise term, for all Vivint Wireless awards.

 

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Table of Contents

Stock-based compensation expense in connection with stock awards is presented by entity as follows (in thousands):

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
         2014              2013              2014              2013      

Operating expenses

   $ 16       $ 33       $ 46       $ 33   

Selling expenses

     32         101         136         101   

General and administrative expenses

     412         509         1,181         1,183   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 460       $ 643       $ 1,363       $ 1,317   
  

 

 

    

 

 

    

 

 

    

 

 

 

NOTE 13—COMMITMENTS AND CONTINGENCIES

Indemnification—Subject to certain limitations, the Company is obligated to indemnify its current and former directors, officers and employees with respect to certain litigation matters and investigations that arise in connection with their service to the Company. These obligations arise under the terms of its certificate of incorporation, its bylaws, applicable contracts, and Delaware and California law. The obligation to indemnify generally means that the Company is required to pay or reimburse the individuals’ reasonable legal expenses and possibly damages and other liabilities incurred in connection with these matters.

Legal—The Company is named from time to time as a party to lawsuits arising in the ordinary course of business related to its sales, marketing, the provision of its services and equipment claims. Actions filed against the Company include commercial, intellectual property, customer, and labor and employment related claims, including complaints of alleged wrongful termination and potential class action lawsuits regarding alleged violations of federal and state wage and hour and other laws. In general, litigation can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings are difficult to predict, and the costs incurred in litigation can be substantial. The Company believes the amounts provided in its financial statements are adequate in light of the probable and estimated liabilities. Factors that the Company considers in the determination of the likelihood of a loss and the estimate of the range of that loss in respect of legal matters include the merits of a particular matter, the nature of the matter, the length of time the matter has been pending, the procedural posture of the matter, how the Company intends to defend the matter, the likelihood of settling the matter and the anticipated range of a possible settlement. Because such matters are subject to many uncertainties, the ultimate outcomes are not predictable and there can be no assurances that the actual amounts required to satisfy alleged liabilities from the matters described above will not exceed the amounts reflected in the Company’s financial statements or that the matters will not have a material adverse effect on the Company’s results of operations, financial condition or cash flows.

The Company regularly reviews outstanding legal claims and actions to determine if reserves for expected negative outcomes of such claims and actions are necessary. The Company had reserves for all such matters of approximately $7.6 million and $9.3 million as of September 30, 2014 and December 31, 2013, respectively. In conjunction with one of the settlements, the Company is obligated to pay certain future royalties, based on sales of future products.

Operating Leases—The Company leases office, warehouse space, certain equipment, software and an aircraft under operating leases with related and unrelated parties expiring in various years through 2028. The leases require the Company to pay additional rent for increases in operating expenses and real estate taxes and contain renewal options. The Company entered into a lease agreement for its corporate headquarters in 2009. In July 2012, the Company entered into a lease for additional office space for an initial lease term of 15 years. In August 2014, the Company entered into a lease for additional office space for an initial lease term of 11 years.

Total rent expense for operating leases was approximately $2.8 million and $1.4 million for the three months ended September 30, 2014 and 2013, respectively, and $7.2 million and $4.1 million for the nine months ended September 30, 2014 and 2013, respectively.

Capital Leases—The Company also leases certain equipment under capital leases with expiration dates through August 2016. On an ongoing basis, the Company enters into vehicle lease agreements under a Fleet Lease Agreement. The lease agreements are typically 36 month leases for each vehicle and the average remaining life for the fleet is 27 months as of September 30, 2014. As of September 30, 2014 and December 31, 2013, the capital lease obligation balance was $13.3 million and $10.5 million, respectively.

 

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Table of Contents

NOTE 14—RELATED PARTY TRANSACTIONS

Long-term investments and other assets, includes amounts due for non-interest bearing advances made to employees that are expected to be repaid in excess of one year. Amounts due from related parties as of both September 30, 2014 and December 31, 2013, amounted to approximately $0.3 million. As of September 30, 2014 and December 31, 2013, this amount was fully reserved.

Prepaid expenses and other current assets at September 30, 2014 and December 31, 2013 included a receivable for $25,000 and $0.3 million, respectively, from certain members of management in regards to their personal use of the corporate jet.

The Company incurred additional expenses of $0.5 million and $0.3 million during the three months ended September 30, 2014 and 2013, respectively, and $1.7 million and $0.6 million during the nine months ended September 30, 2014 and 2013, respectively, for other related-party transactions including contributions to the charitable organization Vivint Gives Back, legal fees, and services. Accrued expenses and other current liabilities at September 30, 2014 and December 31, 2013, included a payable to Vivint Gives Back for $0.2 million and $1.1 million, respectively. In addition, transactions with Solar, as described in Note 4, are considered to be related-party transactions.

On November 16, 2012, the Company entered into a support and services agreement with Blackstone Management Partners L.L.C. (“BMP”), an affiliate of Blackstone. Under the support and services agreement, the Company engaged BMP to provide monitoring, advisory and consulting services on an ongoing basis. In consideration for these services, the Company agreed to pay an annual monitoring fee equal to the greater of (i) a minimum base fee of $2.7 million subject to adjustments if the Company engages in a business combination or disposition that is deemed significant and (ii) the amount of the monitoring fee paid in respect of the immediately preceding fiscal year, without regard to any post-fiscal year “true-up” adjustments as determined by the agreement. The Company incurred expenses of approximately $0.8 million and $1.9 million during the three months ended September 30, 2014 and 2013, respectively, and approximately $2.4 million and $3.5 million during the nine months ended September 30, 2014 and 2013, respectively.

Under the support and services agreement, the Company also engaged BMP to arrange for Blackstone’s portfolio operations group to provide support services customarily provided by Blackstone’s portfolio operations group to Blackstone’s private equity portfolio companies of a type and amount determined by such portfolio services group to be warranted and appropriate. BMP will invoice the Company for such services based on the time spent by the relevant personnel providing such services during the applicable period but in no event shall the Company be obligated to pay more than $1.5 million during any calendar year.

On September 3, 2014, APX Group, Inc., a wholly-owned subsidiary of the Company, paid a dividend in the amount of $50.0 million to its stockholders.

Transactions involving related parties cannot be presumed to be carried out at an arm’s-length basis.

NOTE 15—SEGMENT REPORTING

Prior to the 2GIG Sale on April 1, 2013, the Company conducted business through two operating segments, Vivint and 2GIG. These segments were managed and evaluated separately by management due to the differences in their products and services. The primary source of revenue for the Vivint segment is generated through monitoring services provided to subscribers, in accordance with their subscriber contracts. The primary source of revenue for the 2GIG segment was through the sale of electronic security and automation systems to security dealers and distributors, including Vivint. Fees and expenses charged by 2GIG to Vivint, related to intercompany purchases, were eliminated in consolidation.

 

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Table of Contents

For the three months ended September 30, 2014 and 2013 and the nine months ended September 30, 2014, the Company conducted business through one operating segment, Vivint. The following table presents a summary of revenue, costs and expenses for the nine months ended September 30, 2013 and assets as of September 30, 2013 (in thousands):

 

     Vivint     2GIG      Eliminations     Consolidated Total  

Revenues

   $ 350,690      $ 60,220       $ (42,713   $ 368,197   

All other costs and expenses

     389,321        52,200         (32,914     408,607   
  

 

 

   

 

 

    

 

 

   

 

 

 

(Loss) income from operations

   $ (38,631   $ 8,020       $ (9,799   $ (40,410
  

 

 

   

 

 

    

 

 

   

 

 

 

Intangible assets, including goodwill

   $ 1,720,152      $ —         $ —        $ 1,720,152   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

   $ 2,291,541      $ —         $ —        $ 2,291,541   
  

 

 

   

 

 

    

 

 

   

 

 

 

NOTE 16—EMPLOYEE BENEFIT PLANS

Beginning March 1, 2010, Vivint and 2GIG offered eligible employees the opportunity to defer a percentage of their earned income into company-sponsored 401(k) plans. 2GIG made matching contributions to the plan in the amount of $36,000 for the nine months ended September 30, 2013. No matching contributions were made to the plans for the three or nine months ended September 30, 2014 or the three months ended September 30, 2013.

NOTE 17—GUARANTOR AND NON-GUARANTOR SUPPLEMENTAL FINANCIAL INFORMATION

The Senior Secured Notes due 2019 and the Senior Notes due 2020 were issued by APX. The Senior Secured Notes due 2019 and the Senior Notes due 2020 are fully and unconditionally guaranteed, jointly and severally by APX Group Holdings, Inc. (“Parent Guarantor”) and each of APX’s existing and future material wholly-owned U.S. restricted subsidiaries. APX’s existing and future foreign subsidiaries are not expected to guarantee the Notes.

Presented below is the condensed consolidating financial information of APX, subsidiaries of APX that are guarantors (the “Guarantor Subsidiaries”), and APX’s subsidiaries that are not guarantors (the “Non-Guarantor Subsidiaries”) as of September 30, 2014 and December 31, 2013 and for the three and nine months ended September 30, 2014 and 2013. The unaudited condensed consolidating financial information reflects the investments of APX in the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries using the equity method of accounting.

 

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Table of Contents

Supplemental Condensed Consolidating Balance Sheet

September 30, 2014

(In thousands)

(unaudited)

 

     Parent      APX Group, Inc.     Guarantor
Subsidiaries
     Non-Guarantor
Subsidiaries
     Eliminations     Consolidated  

Assets

               

Current assets

   $ —         $ 29,821      $ 172,094       $ 31,551       $ (40,142   $ 193,324   

Property and equipment, net

     —           —          51,283         594         —          51,877   

Subscriber acquisition costs, net

     —           —          483,723         47,257         —          530,980   

Deferred financing costs, net

     —           54,602        —           —           —          54,602   

Investment in subsidiaries

     261,597         2,087,261        —           —           (2,348,858     —     

Intercompany receivable

     —           —          59,324         —           (59,324     —     

Intangible assets, net

     —           —          677,141         63,105         —          740,246   

Goodwill

     —           —          811,947         30,718         —          842,665   

Restricted cash

     —           —          14,214         —           —          14,214   

Long-term investments and other assets

     —           —          9,858         16         —          9,874   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total Assets

   $ 261,597       $ 2,171,684      $ 2,279,584       $ 173,241       $ (2,448,324   $ 2,437,782   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

               

Current liabilities

   $ —         $ 46,781      $ 193,642       $ 52,231       $ (40,142   $ 252,512   

Intercompany payable

     —           —          —           59,324         (59,324     —     

Notes payable and revolving line of credit, net of current portion

     —           1,863,413        —           —           —          1,863,413   

Capital lease obligations, net of current portion

     —           —          8,950         11         —          8,961   

Deferred revenue, net of current portion

     —           —          29,149         3,145         —          32,294   

Other long-term obligations

     —           —          8,742         379         —          9,121   

Deferred income tax liability

     —           (107     1,396         8,595         —          9,884   

Total equity

     261,597         261,597        2,037,705         49,556         (2,348,858     261,597   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 261,597       $ 2,171,684      $ 2,279,584       $ 173,241       $ (2,448,324   $ 2,437,782   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Supplemental Condensed Consolidating Balance Sheet

December 31, 2013

(In thousands)

(unaudited)

 

     Parent      APX Group, Inc.     Guarantor
Subsidiaries
     Non-Guarantor
Subsidiaries
     Eliminations     Consolidated  

Assets

               

Current assets

   $ —         $ 249,209      $ 89,768       $ 7,163       $ (24,137   $ 322,003   

Property and equipment, net

     —           —          35,218         600         —          35,818   

Subscriber acquisition costs, net

     —           —          262,064         26,252         —          288,316   

Deferred financing costs, net

     —           59,375        —           —           —          59,375   

Investment in subsidiaries

     490,243         1,953,465        —           —           (2,443,708     —     

Intercompany receivable

     —           —          44,658         —           (44,658     —     

Intangible assets, net

     —           —          764,296         76,418         —          840,714   

Goodwill

     —           —          804,041         32,277         —          836,318   

Restricted cash

     —           —          14,214         —           —          14,214   

Long-term investments and other assets

     —           (302     27,954         24         —          27,676   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total Assets

   $ 490,243       $ 2,261,747      $ 2,042,213       $ 142,734       $ (2,512,503   $ 2,424,434   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 
               

Liabilities and Stockholders’ Equity

               

Current liabilities

   $ —         $ 9,561      $ 117,544       $ 31,254       $ (24,137   $ 134,222   

Intercompany payable

     —           —          —           44,658         (44,658     —     

Notes payable and revolving line of credit, net of current portion

     —           1,762,049        —           —           —          1,762,049   

Capital lease obligations, net of current portion

     —           —          6,268         —           —          6,268   

Deferred revenue, net of current portion

     —           —          16,676         1,857         —          18,533   

Other long-term obligations

     —           —          3,559         346         —          3,905   

Deferred income tax liability

     —           (106     289         9,031         —          9,214   

Total equity

     490,243         490,243        1,897,877         55,588         (2,443,708     490,243   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 490,243       $ 2,261,747      $ 2,042,213       $ 142,734       $ (2,512,503   $ 2,424,434   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

Condensed Consolidating Statements of Operations and Comprehensive Loss

For the Three Months Ended September 30, 2014

(In thousands)

(unaudited)

 

     Parent     APX Group, Inc.     Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Consolidated  

Revenues

   $ —        $ —        $ 138,497      $ 9,165      $ (767   $ 146,895   

Costs and expenses

     —          —          159,420        10,640        (767     169,293   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     —          —          (20,923     (1,475     —          (22,398

Loss from subsidiaries

     (59,464     (21,829     —          —          81,293        —     

Other income (expense), net

     50,000        (37,635     (683     (12     (50,000     (38,330
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income tax expenses

     (9,464     (59,464     (21,606     (1,487     31,293        (60,728

Income tax expense

     —          —          (849     (415     —          (1,264
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (9,464   $ (59,464   $ (20,757   $ (1,072   $ 31,293      $ (59,464
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss, net of tax effects:

            

Net loss

   $ (9,464   $ (59,464   $ (20,757   $ (1,072   $ 31,293      $ (59,464

Foreign currency translation adjustment

     —          (7,099     (4,753     (2,346     7,099        (7,099
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive loss

     —          (7,099     (4,753     (2,346     7,099        (7,099
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (9,464   $ (66,563   $ (25,510   $ (3,418   $ 38,392      $ (66,563
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Condensed Consolidating Statements of Operations and Comprehensive Loss

For the Three Months Ended September 30, 2013

(In thousands)

(unaudited)

 

     Parent     APX Group, Inc.     Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Consolidated  

Revenues

   $ —        $ —        $ 123,030      $ 7,218      $ (745   $ 129,503   

Costs and expenses

     —          —          130,593        8,344        (745     138,192   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     —          —          (7,563     (1,126     —          (8,689

Loss from subsidiaries

     (34,905     (5,441     —          —          40,346        —     

Other (expense) income, net

     —          (29,464     428        (45     —          (29,081
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income tax expenses

     (34,905     (34,905     (7,135     (1,171     40,346        (37,770

Income tax benefit

     —          —          (2,486     (379     —          (2,865
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (34,905   $ (34,905   $ (4,649   $ (792   $ 40,346      $ (34,905
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss, net of tax effects:

            

Net loss

   $ (34,905   $ (34,905   $ (4,649   $ (792   $ 40,346      $ (34,905

Foreign currency translation adjustment

     —          3,006        1,763        1,243        (3,006     3,006   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive loss

     —          3,006        1,763        1,243        (3,006     3,006   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive (loss) income

   $ (34,905   $ (31,899   $ (2,886   $ 451      $ 37,340      $ (31,899
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Condensed Consolidating Statements of Operations and Comprehensive Loss

For the Nine Months Ended September 30, 2014

(In thousands)

(unaudited)

 

     Parent     APX Group, Inc.     Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Consolidated  

Revenues

   $ —        $ —        $ 387,985      $ 25,623      $ (2,360   $ 411,248   

Costs and expenses

     —          —          450,099        28,582        (2,360     476,321   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     —          —          (62,114     (2,959     —          (65,073

Loss from subsidiaries

     (173,015     (64,774     —          —          237,789        —     

Other income (expense), net

     50,000        (108,207     (24     (30     (50,000     (108,261
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income tax expenses

     (123,015     (172,981     (62,138     (2,989     187,789        (173,334

Income tax expense

     —          34        (809     456        —          (319
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (123,015   $ (173,015   $ (61,329   $ (3,445   $ 187,789      $ (173,015
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, net of tax effects:

            

Net loss

   $ (123,015   $ (173,015   $ (61,329   $ (3,445   $ 187,789      $ (173,015

Foreign currency translation adjustment

     —          (6,994     (4,408     (2,586     6,994        (6,994
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive loss

     —          (6,994     (4,408     (2,586     6,994        (6,994
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (123,015   $ (180,009   $ (65,737   $ (6,031   $ 194,783      $ (180,009
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Condensed Consolidating Statements of Operations and Comprehensive Loss

For the Nine Months Ended September 30, 2013

(In thousands)

(unaudited)

 

     Parent     APX Group, Inc.     Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Consolidated  

Revenues

   $ —        $ —        $ 350,358      $ 20,103      $ (2,264   $ 368,197   

Costs and expenses

     —          —          387,796        23,075        (2,264     408,607   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     —          —          (37,438     (2,972     —          (40,410

Loss from subsidiaries

     (87,341     (51,671     —          —          139,012        —     

Other expense, net

     60,000        (35,670     405        (68     (60,000     (35,333
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income tax expenses

     (27,341     (87,341     (37,033     (3,040     79,012        (75,743

Income tax expense (benefit)

     —          —          12,447        (849     —          11,598   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (27,341   $ (87,341   $ (49,480   $ (2,191   $ 79,012      $ (87,341
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss, net of tax effects:

            

Net loss

   $ (27,341   $ (87,341   $ (49,480   $ (2,191   $ 79,012      $ (87,341

Foreign currency translation adjustment

     —          (3,981     (1,959     (2,022     3,981        (3,981
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive loss

     —          (3,981     (1,959     (2,022     3,981        (3,981
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (27,341   $ (91,322   $ (51,439   $ (4,213   $ 82,993      $ (91,322
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Supplemental Condensed Consolidating Statements of Cash Flows

For the Nine Months Ended September 30, 2014

(In thousands)

(unaudited)

 

     Parent     APX Group, Inc.     Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Consolidated  

Cash flows from operating activities:

            

Net cash provided by (used in) operating activities

   $ 50,000      $ (1,725   $ 56,833      $ 36,548      $ (50,000   $ 91,656   

Cash flows from investing activities:

            

Subscriber contract costs

     —          —          (258,407     (26,505     —          (284,912

Capital expenditures

     —          —          (19,668     (188     —          (19,856

Investment in subsidiary

     —          (266,649     —          —          266,649        —     

Acquisition of intangible assets

     —          —          (6,421     —          —          (6,421

Net cash used in acquisition

     —          —          (18,500     —          —          (18,500

Investment in marketable securities

     —          (60,000     —          —          —          (60,000

Proceeds from marketable securities

     —          60,069        —          —          —          60,069   

Investment in convertible note

     —          —          (3,000     —          —          (3,000

Other assets

     —          —          (99     7        —          (92
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     —          (266,580     (306,095     (26,686     266,649        (332,712

Cash flows from financing activities:

            

Proceeds from issuance of notes

     —          102,000        —          —          —          102,000   

Intercompany receivable

     —          —          (14,666     —          14,666        —     

Intercompany payable

     —          —          266,649        14,666        (281,315     —     

Proceeds from contract sales

     —          —          2,261        —          —          2,261   

Change in restricted cash

     —          —          161        —          —          161   

Repayments of capital lease obligations

     —          —          (4,526     (2     —          (4,528

Deferred financing costs

     —          (2,782     —          —          —          (2,782

Payment of dividends

     (50,000     (50,000     —          —          50,000        (50,000
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     (50,000     49,218        249,879        14,664        (216,649     47,112   

Effect of exchange rate changes on cash

     —          —          —          (775     —          (775
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash

     —          (219,087     617        23,751        —          (194,719

Cash:

            

Beginning of period

     —          248,908        8,291        4,706        —          261,905   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

End of period

   $ —        $ 29,821      $ 8,908      $ 28,457      $ —        $ 67,186   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Supplemental Condensed Consolidating Statements of Cash Flows

For the Nine Months Ended September 30, 2013

(In thousands)

(unaudited)

 

     Parent     APX Group, Inc.     Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Consolidated  

Cash flows from operating activities:

            

Net cash provided by (used in) operating activities

   $ 60,000      $ (115   $ 105,177      $ 34,609      $ (60,000   $ 139,671   

Cash flows from investing activities:

            

Subscriber contract costs

     —          —          (240,678     (26,554     —          (267,232

Capital expenditures

     —          —          (5,764     (24     —          (5,788

Proceeds from the sale of subsidiary

     —          144,750        —          —          —          144,750   

Investment in subsidiary

     —          (178,077     —          —          178,077        —     

Proceeds from the sale of capital assets

     —          —          9        —          —          9   

Net cash used in acquisition

     —          —          (4,272     —          —          (4,272

Other assets

     —          —          (8,192     3        —          (8,189
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     —          (33,327     (258,897     (26,575     178,077        (140,722

Cash flows from financing activities:

            

Proceeds from note payable

     —          203,500        —          —          —          203,500   

Intercompany receivable

     —          —          (9,451     —          9,451        —     

Intercompany payable

     —          —          178,077        9,451        (187,528     —     

Repayments of revolving line of credit

     —          (50,500     —          —          —          (50,500

Borrowings from revolving line of credit

     —          22,500        —          —          —          22,500   

Repayments of capital lease obligations

     —          —          (5,208     —          —          (5,208

Deferred financing costs

       (5,429     —          —          —          (5,429

Payment of dividends

     (60,000     (60,000     —          —          60,000        (60,000
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     (60,000     110,071        163,418        9,451        (118,077     104,863   

Effect of exchange rate changes on cash

     —          —          —          (169     —          (169
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase in cash

     —          76,629        9,698        17,316        —          103,643   

Cash:

            

Beginning of period

     —          399        4,188        3,503        —          8,090   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

End of period

   $ —        $ 77,028      $ 13,886      $ 20,819      $ —        $ 111,733   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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NOTE 18—SUBSEQUENT EVENT

On October 10, 2014, in connection with the completion of its initial public offering, Solar repaid loans under the Subordinated Note and Loan Agreement (See Note 4) to APX Group, Inc., a wholly-owned subsidiary of the Company, and the Company’s parent entity. The Company’s parent entity, in turn, returned a portion of such proceeds to APX Group, Inc. as a capital contribution. These transactions resulted in the receipt by APX Group, Inc. of an aggregate amount of $55.0 million.

A portion of the $55.0 million received by APX Group, Inc. represented repayment of the entire Solar loan balance, consisting of principal of $20.0 million and accrued interest of $2.2 million. Accordingly, the respective balances were reclassified from long-term investments and other assets, net, to prepaid and other current assets in the accompanying unaudited condensed consolidated balance sheet as of September 30, 2014 (See Note 6).

Also in connection with Solar’s initial public offering, the Company entered into a number of agreements with Solar related to services and other support that the Company has provided and will provide to Solar including:

 

    A Master Intercompany Framework Agreement which establishes a framework for the ongoing relationship between the Company and Solar and contains master terms regarding the protection of each other’s confidential information, and master procedural terms, such as notice procedures, restrictions on assignment, interpretive provisions, governing law and dispute resolution;

 

    A Non-Competition Agreement in which the Company and Solar each define their current areas of business and their competitors, and agree not to directly or indirectly engage in the other’s business for three years;

 

    A Transition Services Agreement pursuant to which the Company will provide to Solar various enterprise services, including services relating to information technology and infrastructure, human resources and employee benefits, administration services and facilities-related services;

 

    A Product Development and Supply Agreement pursuant to which one of Solar’s wholly owned subsidiaries will, for an initial term of three years, subject to automatic renewal for successive one-year periods unless either party elects otherwise, collaborate with the Company to develop certain monitoring and communications equipment that will be compatible with other equipment used in Solar’s energy systems and will replace equipment Solar currently procures from third parties;

 

    A Marketing and Customer Relations Agreement which governs various cross-marketing initiatives between the Company and Solar, in particularly the provision of sales leads from each company to the other; and

 

    A Trademark License Agreement pursuant to which the licensor, a special purpose subsidiary majority-owned by the Company and minority-owned by Solar, will grant Solar a royalty-free exclusive license to the trademark “VIVINT SOLAR” in the field of selling renewable energy or energy storage products and services.

Transactions with Solar are considered for accounting purposes to be related-party transactions.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of our consolidated results of operations and financial condition. The discussion should be read in conjunction with the consolidated financial statements and notes thereto contained in the Annual Report on Form 10-K for the year ended December 31, 2013. This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in the “Risk Factors” section of this Quarterly Report. Actual results may differ materially from those contained in any forward-looking statements. Unless the context otherwise requires, references to “we”, “us”, “our”, and the “Company” are intended to mean the business and operations of APX Group Holdings, Inc. and its consolidated subsidiaries.

Non-GAAP Financial Measures

This Quarterly Report on Form 10-Q includes Adjusted EBITDA, which is a supplemental measure that is not required by, or presented in accordance with, accounting principles generally accepted in the United States (“GAAP”). It is not a measurement of our financial performance under GAAP and should not be considered as an alternative to net income or any other measure derived in accordance with GAAP or as an alternative to cash flows from operating activities as a measure of our liquidity. We define “Adjusted EBITDA” as net income (loss) before interest expense (net of interest income), income and franchise taxes, and depreciation and amortization (including amortization of capitalized subscriber acquisition costs), further adjusted to exclude the effects of certain contract sales to third parties, non-capitalized subscriber acquisition costs, stock based compensation and certain unusual, non-cash, non-recurring and other items permitted in certain covenant calculations under the indentures governing our existing senior secured notes and our existing senior unsecured notes and the credit agreement governing our revolving credit facility. We caution investors that amounts presented in accordance with our definition of Adjusted EBITDA may not be comparable to similar measures disclosed by other issuers, because not all issuers and analysts calculate Adjusted EBITDA in the same manner. We believe that Adjusted EBITDA provides useful information about flexibility under our covenants to investors, lenders, financial analysts and rating agencies since these groups have historically used EBITDA-related measures in our industry, along with other measures, to estimate the value of a company, to make informed investment decisions, and to evaluate a company’s ability to meet its debt service requirements. Adjusted EBITDA eliminates the effect of non-cash depreciation of tangible assets and amortization of intangible assets, much of which results from acquisitions accounted for under the purchase method of accounting. Adjusted EBITDA also eliminates the effects of interest rates and changes in capitalization which management believes may not necessarily be indicative of a company’s underlying operating performance. Adjusted EBITDA is also used by us to measure covenant compliance under the indentures governing our existing senior secured notes and our existing senior unsecured notes and the credit agreement governing our revolving credit facility.

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Financial Resources” for a reconciliation of Adjusted EBITDA to net loss, as we believe net loss is the most comparable financial measure calculated in accordance with GAAP. Adjusted EBITDA should be considered in addition to and not as a substitute for, or superior to, financial measures presented in accordance with GAAP.

Business Overview

We are one of the largest home automation companies in North America. In February 2013, we were recognized by Forbes magazine as one of America’s Most Promising Companies. Our fully integrated and remotely accessible residential services platform offers subscribers a suite of products and services that includes interactive security, life-safety, energy management and home automation. We utilize a scalable direct-to-home sales model to originate a majority of our new subscribers, which allows us control over our net subscriber acquisition costs. We have built a high-quality subscriber portfolio, with an average credit score of 713, as of September 30, 2014, through our underwriting criteria and compensation structure. Unlike many of our competitors, who generally focus on either subscriber origination or servicing, we originate, install, service and monitor our entire subscriber base, which allows us to control the overall subscriber experience. We seek to deliver a quality subscriber experience with a

 

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combination of innovative development of new products and services and a commitment to customer service, which together with our focus on originating high-quality new subscribers, has enabled us to achieve attrition rates that we believe are historically at or below industry averages. Utilizing this model, we have built a portfolio of approximately 899,000 subscribers, as of September 30, 2014. Approximately 95% of our revenues during both the three months ended September 30, 2014 and 2013 and 96% and 91% during the nine months ended September 30, 2014 and 2013, respectively, consisted of contractually committed recurring revenues, which have historically resulted in consistent and predictable operating results.

Recent Transactions

On April 1, 2013, we completed the sale of 2GIG Technologies, Inc. and its subsidiary (“2GIG”) to Nortek, Inc. (the “2GIG Sale”). Pursuant to the terms of the 2GIG Sale, Nortek, Inc. (“Nortek”) acquired all of the outstanding common stock of 2GIG for aggregate cash consideration of approximately $148.9 million. In connection with the 2GIG Sale, we retained sole ownership of the intellectual property and exclusive rights with respect to the next generation of our control panels and certain peripheral equipment. We expect this proprietary equipment will be a critical component of our future service offerings. In addition, we entered into a five-year supply agreement with 2GIG, pursuant to which they will be the exclusive provider of our control panel requirements, subject to certain exceptions as provided in the supply agreement. A portion of the net proceeds from the 2GIG Sale were used to temporarily repay $44.0 million of outstanding borrowings under our revolving credit facility. The terms of the indentures governing the notes and the credit agreement governing our revolving credit facility permit us, subject to certain conditions, to distribute all or a portion of the net proceeds from the 2GIG Sale to our stockholders. In May 2013, we distributed $60.0 million of such proceeds to our stockholders. Subject to the applicable conditions, we may distribute the remaining proceeds in the future. Our results of operations include the results of 2GIG through the date of the 2GIG Sale.

In May and December 2013, we issued and sold an additional $200.0 million and $250.0 million, respectively, aggregate principal amount of 8.75% senior notes due 2020. On July 1, 2014, we issued and sold an additional $100.0 million aggregate principal amount of 8.75% senior notes due 2020.

On September 3, 2014, APX Group, Inc. paid a dividend in the amount of $50.0 million to APX Group Holdings, Inc., its sole stockholder, which in turn paid a dividend in the amount of $50.0 million to its stockholders.

On October 10, 2014, in connection with the completion of its initial public offering, Solar repaid loans (See Note 4 of the accompanying condensed consolidated financial statements) to APX Group, Inc., our wholly-owned subsidiary, and our parent entity. Our parent entity, in turn, returned a portion of such proceeds to APX Group, Inc. as a capital contribution. These transactions resulted in the receipt by APX Group, Inc. of an aggregate amount of $55.0 million.

Also in connection with Solar’s initial public offering, we negotiated on an arm’s-length basis and entered into a number of agreements with Solar related to services and other support that we have provided and will provide to Solar including:

 

    A Master Intercompany Framework Agreement which establishes a framework for the ongoing relationship between us and Solar and contains master terms regarding the protection of each other’s confidential information, and master procedural terms, such as notice procedures, restrictions on assignment, interpretive provisions, governing law and dispute resolution;

 

    A Non-Competition Agreement in which we and Solar each define our current areas of business and our competitors, and agree not to directly or indirectly engage in the other’s business for three years;

 

    A Transition Services Agreement pursuant to which we will provide to Solar various enterprise services, including services relating to information technology and infrastructure, human resources and employee benefits, administration services and facilities-related services;

 

    A Product Development and Supply Agreement pursuant to which one of Solar’s wholly owned subsidiaries will, for an initial term of three years, subject to automatic renewal for successive one-year periods unless either party elects otherwise, collaborate with us to develop certain monitoring and communications equipment that will be compatible with other equipment used in Solar’s energy systems and will replace equipment Solar currently procures from third parties;

 

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    A Marketing and Customer Relations Agreement which governs various cross-marketing initiatives between us and Solar, in particularly the provision of sales leads from each company to the other; and

 

    A Trademark License Agreement pursuant to which the licensor, a special purpose subsidiary majority-owned by us and minority-owned by Solar, will grant Solar a royalty-free exclusive license to the trademark “VIVINT SOLAR” in the field of selling renewable energy or energy storage products and services.

Basis of Presentation

The unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2014 and 2013, respectively, present the financial position and results of operations of APX Group Holdings, Inc. and its wholly-owned subsidiaries. We have historically conducted business through our Vivint and 2GIG operating segments. On April 1, 2013, we completed the sale of 2GIG to Nortek. See “—Recent Transactions.” Therefore, 2GIG is excluded from our operating results, beginning on the date of the 2GIG Sale. The results of our 2GIG operating segment include the results of 2GIG, which was our consolidated subsidiary until its sale to Nortek.

Historically, a substantial majority of 2GIG’s revenues were generated from Vivint through (i) sales of its security systems; and (ii) fees billed to Vivint associated with a third-party monitoring platform. Sales to Vivint represented approximately 71% of 2GIG’s revenues on a stand-alone basis from January 1, 2013 through the date of the 2GIG Sale. The results of 2GIG’s operations discussed in this Quarterly Report on Form 10-Q exclude intercompany activity with Vivint, as these transactions were eliminated in consolidation.

The term “attrition” as used in this quarterly report on Form 10-Q refers to the aggregate number of cancelled subscribers during a period divided by the monthly weighted average number of total subscribers for such period. Subscribers are considered cancelled when they terminate in accordance with the terms of their contract, are terminated by us or if payment from such subscribers is deemed uncollectible (120 days past due). Sales of contracts to third parties and certain subscriber residential moves are excluded from the attrition calculation. The term “net subscriber acquisition costs” as used in this quarterly report on Form 10-Q refers to the gross costs to generate and install a subscriber net of any fees collected at the time of the contract signing. The term “RMR” is the recurring monthly revenue billed to a subscriber. The term “total RMR” is the aggregate RMR billed to all subscribers. The term “total subscribers” is the aggregate number of our active subscribers at the end of a given period. The term “average RMR per subscriber” is the total RMR divided by the total subscribers. This is also commonly referred to as Average Revenue per User, or “ARPU.” The term “average RMR per new subscriber” is the aggregate RMR for new subscribers originated during a period divided by the number of new subscribers originated during such period.

Key Factors Affecting Operating Results

Our business is driven through the generation of new subscribers and servicing and maintaining our existing subscriber base. The generation of new subscribers requires significant upfront investment, which in turn provides predictable contractual recurring monthly revenue generated from our monitoring and additional services. We market our service offerings through two sales channels, direct-to-home and inside sales. Historically, most of our new subscriber accounts were generated through direct-to-home sales, primarily from April through August. New subscribers generated through inside sales was approximately 24% of total new subscriber additions in the twelve months ended September 30, 2014, as compared to 23% of total new subscribers in the twelve months ended September 30, 2013. Over time, we expect the number of subscribers originated through inside sales to continue to increase, resulting from increased advertising and expansion of our direct-sales calling centers.

Our operating results are impacted by the following key factors: number of subscriber additions, net subscriber acquisition costs, average RMR per subscriber, subscriber adoption rate of additional services beyond our Advanced Home Security package, subscriber attrition, the costs to monitor and service our subscribers, the level of general and administrative expenses and the availability and cost of capital required to generate new subscribers. We focus our investment decisions on generating new subscribers and servicing our existing subscribers in the most cost-effective manner, while maintaining a high level of customer service to minimize subscriber attrition. These

 

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decisions are based on the projected cash flows and associated margins generated over the expected life of the subscriber relationship. Attrition is defined as the aggregate number of cancelled subscribers during a period divided by the monthly weighted average number of total subscribers for such period. Subscribers are considered cancelled when they terminate in accordance with the terms of their contract, are terminated by us, or if payment from such subscribers is deemed uncollectible (120 days past due). Sales of contracts to third parties and certain subscriber moves are excluded from the attrition calculation.

Our ability to increase subscribers depends on a number of factors, both external and internal. External factors include the overall macroeconomic environment and competition from other companies in the geographies we serve, particularly in those markets where our direct-to-home sales representatives are present. Some of our current competitors have longer operating histories, greater name recognition and substantially greater financial and marketing resources than us. In the future, other companies may also choose to begin offering services similar to ours. In addition, because such a large percentage of our new subscribers are generated through direct-to-home sales, any actions limiting this sales channel could negatively affect our ability to grow our subscriber base. We are continually evaluating ways to improve the effectiveness of our subscriber acquisition activities in both our direct-to-home and inside sales channels. For example, during 2014 we introduced alternative awareness and demand generation strategies using broad media sources in a limited number of markets throughout the U.S. in an effort to reach additional consumers and increase sales leads.

Internal factors include our ability to recruit, train and retain personnel, along with the level of investment in sales and marketing efforts. We believe maintaining competitive compensation structures, differentiated product offerings and establishing a strong brand are critical to attracting and retaining high-quality personnel and competing effectively in the markets we serve. As a result, we expect to increase our investment in advertising in the markets we serve, in an effort to generate greater awareness of the Vivint brand. Successfully growing our revenue per subscriber depends on our ability to continue expanding our technology platform by offering additional value added services demanded by the market. Therefore, we continually evaluate the viability of additional service packages that could further leverage our existing technology platform and sales channels. As evidence of this focus on new services, since 2010, we have successfully expanded our service packages from residential security into energy management, security plus and home automation, which allows us to charge higher RMR for these additional services. During 2013, we began offering high-speed wireless internet to a limited number of residential customers and in 2014, we began offering identity protection services. In August 2014, we also acquired a data cloud storage technology that we expect to begin offering in late 2014. These service offerings leverage our existing direct-to-home selling model for the generation of new subscribers. During the nine months ended September 30, 2014, approximately 70% of our new subscribers contracted for one of our additional service packages. Due to the high rate of adoption for these additional service packages, our average RMR per new subscriber has increased from $44.50 in 2009 to $61.86 for the nine months ended September 30, 2014, an increase of 40%.

We focus on managing the costs associated with monitoring and service without jeopardizing our award-winning service quality. We believe our ability to retain subscribers over the long-term starts with our underwriting criteria and is enhanced by maintaining our consistent quality service levels.

Subscriber attrition has a direct impact on the number of subscribers who we monitor and service and on our financial results, including revenues, operating income and cash flows. A portion of the subscriber base can be expected to cancel its service every year. Subscribers may choose not to renew or may terminate their contracts for a variety of reasons, including relocation, cost, switching to a competitor’s service or service issues. If a subscriber relocates but continues their service, we do not consider this as a cancellation. If a subscriber discontinues their service and transfers the original subscriber’s contract to a new subscriber continuing the revenue stream, we also do not consider this as a cancellation. We analyze our attrition by tracking the number of subscribers who cancel as a percentage of the average number of subscribers at the end of each twelve month period. We caution investors that not all companies, investors and analysts in our industry define attrition in the same manner.

 

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The table below presents subscriber data for Vivint for the twelve months ended September 30, 2014 and year the ended December 31, 2013:

 

     Twelve Months
Ended
September 30,
2014
    Year Ended
December 31,
2013
 

Beginning balance of subscribers

     803,413        671,818   

Net new additions

     203,358        219,034   

Subscriber contracts sold

     (2,185     —     

Attrition

     (105,412     (95,352
  

 

 

   

 

 

 

Ending balance of subscribers

     899,174        795,500   
  

 

 

   

 

 

 

Monthly average subscribers

     824,295        743,544   
  

 

 

   

 

 

 

Attrition rate

     12.8     12.8
  

 

 

   

 

 

 

Historically, we have experienced an increased level of subscriber cancellations in the months surrounding the expiration of such subscribers’ initial contract term. Attrition in any twelve-month period may be impacted by the number of subscriber contracts reaching the end of their initial term in such period. We believe this trend in cancellation at the end of the initial contract term is comparable to other companies within our industry.

How We Generate Revenue

Vivint

Our primary source of revenue is generated through monitoring services provided to our subscribers in accordance with their subscriber contracts. The remainder of our revenue is generated through additional services, activation fees, upgrades and maintenance and repair fees. Monitoring revenues accounted for 95% of total revenues for both the three months ended September 30, 2014 and 2013 and 96% and 95% for the nine months ended September 30, 2014 and 2013, respectively.

Monitoring revenue. Monitoring services for our subscriber contracts are billed in advance, generally monthly, pursuant to the terms of subscriber contracts and recognized ratably over the service period. The amount of RMR billed is dependent upon which of our service packages the subscriber contracts for. We generally realize higher RMR for our Home Automation, Energy Management and Security Plus service packages than our Home Security service package. Historically, we have generally offered contracts to subscribers that range in length from 36 to 60 months that are subject to automatic annual or monthly renewal after the expiration of the initial term. At the end of each monthly period, the portion of monitoring fees related to services not yet provided are deferred and recognized as these services are provided.

Service and other sales revenue. Our service and other sales revenue is primarily comprised of amounts charged for selling additional equipment, and maintenance and repair. These amounts are billed, and the associated revenue recognized, at the time of installation or when the services are performed. Service and other sales revenue also includes contract fulfillment revenue, which relates to amounts paid by subscribers who cancel their monitoring contract in-term and for which we have no future service obligation to them. We recognize this revenue upon receipt of payment from the subscriber.

Activation fees. Activation fees represent upfront one-time charges billed to subscribers at the time of installation. The revenue associated with these fees is deferred and recognized over the estimated life using a 150% declining balance method over 12 years and converts to a straight-line methodology when the resulting revenue recognition is greater than that from the accelerated method for the remaining estimated life.

 

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2GIG

2GIG’s primary source of revenue was generated through the sale of electronic home security and automation products to dealers and distributors throughout North America. The remainder of the revenue was earned from monthly recurring service fees. System sales, which are included in service and other sales revenue on our consolidated statements of operations, accounted for approximately 14% of total consolidated revenues from January 1, 2013 through the date of the 2GIG Sale. Product sales accounted for approximately 92% of 2GIG’s total revenues on a stand-alone basis from January 1, 2013 through the date of the 2GIG Sale.

Service and other sales revenue. Net sales revenue from distribution of the 2GIG products was recognized when title to the products transferred to the customer, which occurred upon shipment from our third-party logistics provider’s facility to the customer. Invoicing occurred at the time of shipment and in certain cases, included freight costs based on specific vendor contracts.

Recurring services revenue. Net recurring services revenue was based on back-end services for all panels sold to distributors and direct-sell dealers and subsequently placed in service in end-user locations. The back-end services are provided by Alarm.com, an independent platform services provider. 2GIG received a fixed monthly amount from Alarm.com for each of our systems installed with customers that used the Alarm.com platform.

Costs and Expenses

Vivint

Operating expenses. Operating expenses primarily consists of labor associated with monitoring and servicing subscribers and labor and equipment expenses related to field service. In addition, a portion of general and administrative expenses, comprised of certain human resources, facilities and information technologies costs are allocated to operating expenses. This allocation is primarily based on employee headcount and facility square footage occupied. Because our field service technicians perform most subscriber installations generated through our inside sales channels, the costs incurred by the field service associated with these installations are allocated to capitalized subscriber acquisition costs.

Selling expenses. Selling expenses are primarily comprised of costs associated with housing for our direct-to-home sales representatives, advertising and lead generation, marketing and recruiting, certain portions of sales commissions, overhead (including allocation of certain general and administrative expenses) and other costs not directly tied to a specific subscriber origination. These costs are expensed as incurred.

General and administrative expenses. General and administrative expenses consist largely of finance, legal, research and development, human resources, information technology and executive management expenses, including stock-based compensation expense. Stock-based compensation expense is recorded within various components of our costs and expenses. General and administrative expenses also include the provision for doubtful accounts. We allocate approximately one-third of our gross general and administrative expenses, excluding the provision for doubtful accounts, into operating and selling expenses in order to reflect the overall costs of those components of the business. In addition, we entered into an agreement with Vivint Solar, Inc. (“Solar”) under which we sublease corporate office space, and provide certain other administrative services, to Solar and charge Solar the costs associated with this agreement (See Note 4 to the accompanying unaudited condensed consolidated financial statements).

Depreciation and amortization. Depreciation and amortization consists of depreciation from property and equipment, amortization of equipment leased under capital leases, capitalized subscriber acquisition costs and intangible assets.

 

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2GIG

Operating expenses. 2GIG did not directly manufacture, assemble, warehouse or ship any of the products it sold. Its products were produced by contract manufacturers, and warehoused and fulfilled through third-party logistics providers. Operating expenses primarily consisted of cost of goods sold, freight charges, royalty fees on licensed technology, warehouse expenses, and fulfillment service fees charged by its logistics providers.

General and administrative expenses. General and administrative expenses consisted largely of finance, research and development (“R&D”), including third-party engineering costs, legal, operations, sales commissions, and executive management costs. 2GIG’s personnel-related costs were included in general and administrative expense.

Depreciation and amortization. Depreciation and amortization consisted of depreciation of property and equipment.

Key Operating Metrics

In evaluating our results, we review the key performance measures discussed below. We believe that the presentation of key performance measures is useful to investors and lenders because they are used to measure the value of companies such as ours with recurring revenue streams.

Total Subscribers

Total subscribers is the aggregate number of our active subscribers at the end of a given period.

Total Recurring Monthly Revenue

Total RMR is the aggregate RMR billed to all subscribers. This revenue is earned for Home Automation, Energy Management, Security Plus and Home Security service packages.

Average RMR per Subscriber

Average RMR per subscriber is the total RMR divided by the total subscribers. This is also commonly referred to as Average Revenue per User, or ARPU.

 

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Results of operations

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2014     2013     2014     2013  
     (in thousands)  

Revenue

        

Vivint

   $ 146,895      $ 129,503      $ 411,248      $ 350,690   

2GIG

     —          —          —          17,507   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     146,895        129,503        411,248        368,197   

Costs and expenses

        

Vivint

     169,293        138,192        476,321        389,321   

2GIG

     —          —          —          19,286   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

     169,293        138,192        476,321        408,607   

Loss from continuing operations

        

Vivint

     (22,398     (8,689     (65,073     (38,631

2GIG

     —          —          —          (1,779
  

 

 

   

 

 

   

 

 

   

 

 

 

Total loss from continuing operations

     (22,398     (8,689     (65,073     (40,410

Other expenses

     38,330        29,081        108,261        35,333   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before taxes

     (60,728     (37,770     (173,334     (75,743

Income tax (benefit) expense

     (1,264     (2,865     (319     11,598   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (59,464   $ (34,905   $ (173,015   $ (87,341
  

 

 

   

 

 

   

 

 

   

 

 

 

Key operating metrics (1)

        

Total Subscribers, as of September 30 (thousands)

     899.2        803.4       

Total RMR (thousands) (end of period)

   $ 48,987      $ 42,582       

Average RMR per Subscriber

   $ 54.48      $ 53.00       

 

(1) Reflects Vivint metrics only, excluding the wireless internet business, as of the end of the periods presented

Three Months Ended September 30, 2014 Compared to the Three Months Ended September 30, 2013—Vivint

Revenues

The following table provides the significant components of our revenue for the three month period ended September 30, 2014 and the three month period ended September 30, 2013:

 

     Three Months Ended September 30,         
     2014      2013      % Change  

Monitoring revenue

   $ 140,227       $ 123,329         14

Service and other sales revenue

     5,517         5,587         -1

Activation fees

     1,151         587         96
  

 

 

    

 

 

    

 

 

 

Total revenues

   $ 146,895       $ 129,503         13
  

 

 

    

 

 

    

 

 

 

Total revenues increased $17.4 million, or 13%, for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013, primarily due to the growth in monitoring revenue, which increased $16.9 million, or 14%. This increase resulted from $17.4 million of fees from the net addition of approximately 96,000 subscribers at September 30, 2014 compared to September 30, 2013 and a $5.1 million increase from continued growth in the percentage of our subscribers contracting for new products and service packages, partially offset by a $5.6 million increase in refunds and credits during the period.

Service and other sales revenue decreased $0.1 million, or 1%, for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013. This decrease was primarily due to a decrease in upgrade revenue related to subscriber service upgrades and purchases of additional equipment.

 

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The revenue associated with activation fees is deferred upon billing and recognized over the estimated life of the subscriber relationship. There is deemed to be no fair value associated with deferred activation fee revenues at the time of our acquisition by an investor group led by affiliates of our sponsor, The Blackstone Group L.P. (the “Sponsor”) on November 16, 2012 (the “Acquisition”). Thus, revenues recognized related to activation fees increased $0.6 million, or 96%, for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013, primarily due to the increase in the number of subscribers from whom we have collected activation fees since the date of the Acquisition.

Costs and Expenses

 

     Three Months Ended September 30,         
     2014      2013      % Change  

Operating expenses

   $ 52,770      $ 40,208        31 %

Selling expenses

     26,884        26,488        1 %

General and administrative

     31,792        20,661        54 %

Depreciation and amortization

     57,847        50,835        14 %
  

 

 

    

 

 

    

 

 

 

Total costs and expenses

   $ 169,293      $ 138,192        23 %
  

 

 

    

 

 

    

 

 

 

Operating expenses increased $12.6 million, or 31%, for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013, primarily to support the growth in our subscriber base. This increase was principally comprised of $7.1 million in equipment costs, which included a $3.8 million out-of-period adjustment, primarily related to the reclassification of certain equipment costs from subscriber acquisition costs to operating expenses (see Note 1 to the accompanying unaudited condensed consolidated financial statements), and a $1.3 million charge to write-off products never released for subscriber installations. This increase was also due to $3.2 million in personnel costs within our monitoring, customer support and field service functions and $1.2 million in cellular communications fees related to our monitoring services.

Selling expenses, excluding amortization of capitalized subscriber acquisition costs, increased $0.4 million, or 1%, for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013, primarily due to an increase in facility, administrative and information technology costs of $1.1 million, offset by a $0.5 million decrease in personnel costs.

General and administrative expenses increased $11.1 million, or 54%, for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013, partly due to a $7.8 million increase in personnel costs, primarily related to information technologies, research and development and management staffing to support the expected growth of the business and our wireless internet service. The increase was also due to a $3.9 million increase in brand recognition expenses, along with a $1.2 million increase in the provision for doubtful accounts, primarily related to the growth in our accounts receivable. These increases were partially offset by a $1.5 million decrease in other advertising costs. In addition, in connection with the facility fire described in Note 10 of the accompanying condensed consolidated financial statements, we incurred an estimated $1.4 million of fire related losses, offset by additional probable insurance recoveries of $3.2 million.

Depreciation and amortization increased $7.0 million, or 14%, for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013. The increase was primarily due to increased amortization of subscriber contract costs.

 

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Other Expenses, net

 

     Three Months Ended September 30,        
     2014     2013     % Change  

Interest expense

   $ 38,135      $ 30,055        27 %

Interest income

     (340     (411     -17

Other expense (income), net

     535        (84     -737

Gain on 2GIG Sale

     —          (479     -100
  

 

 

   

 

 

   

 

 

 

Total other expenses, net

   $ 38,330      $ 29,081        32 %
  

 

 

   

 

 

   

 

 

 

Interest expense increased $8.1 million, or 27%, for the three months ended September 30, 2014, as compared with the three months ended September 30, 2013, due to a higher principal balance on our debt related to issuance of $350.0 million in additional senior unsecured notes payable since December 2013. During the three months ended September 30, 2013, we realized a gain of $0.5 million as a result of the 2GIG Sale. See Note 3 of our unaudited Condensed Consolidated Financial Statements for additional information.

Income Taxes

 

     Three Months Ended September 30,        
     2014     2013     % Change  

Income tax benefit

   $ (1,264   $ (2,865     -56

Income tax benefit decreased $1.6 million, or 56%, for the three months ended September 30, 2014 as compared with the three months ended September 30, 2013. The income tax benefit for the three months ended September 30, 2014 related primarily to the release of the valuation allowance as a result of the Space Monkey acquisition. The income tax benefit for the three months ended September 30, 2013 related primarily to the elimination of 2GIG from our results of operations, as a result of the 2GIG Sale on April 1, 2013

Nine Months Ended September 30, 2014 Compared to the Nine Months Ended September 30, 2013—Vivint

Revenues

The following table provides the significant components of our revenue for the nine month period ended September 30, 2014 and the nine month period ended September 30, 2013:

 

     Nine Months Ended September 30,         
     2014      2013      % Change  

Monitoring revenue

   $ 393,383      $ 333,895         18 %

Service and other sales revenue

     15,070        15,844         -5

Activation fees

     2,795        951         194 %
  

 

 

    

 

 

    

 

 

 

Total revenues

   $ 411,248      $ 350,690         17 %
  

 

 

    

 

 

    

 

 

 

Total revenues increased $60.6 million, or 17%, for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013, primarily due to the growth in monitoring revenue, which increased $59.5 million, or 18%. This increase resulted from $52.1 million of fees from the net addition of approximately 96,000 subscribers at September 30, 2014 compared to September 30, 2013 and a $15.8 million increase from continued growth in the percentage of our subscribers contracting for new products and service packages, partially offset by an $8.4 million increase in refunds and credits during the period.

 

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Service and other sales revenue decreased $0.8 million, or 5%, for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. This decrease was primarily due to a decrease in upgrade revenue related to subscriber service upgrades and purchases of additional equipment.

The revenue associated with activation fees is deferred upon billing and recognized over the estimated life of the subscriber relationship. There was deemed to be no fair value associated with deferred activation fee revenues at the time of the Acquisition. Thus, revenues recognized related to activation fees increased $1.8 million, or 194%, for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013, primarily due to the increase in the number of subscribers from whom we have collected activation fees since the date of the Acquisition.

Costs and Expenses

 

     Nine Months Ended September 30,         
     2014      2013      % Change  

Operating expenses

   $ 141,303      $ 112,669         25

Selling expenses

     81,202        75,394         8

General and administrative

     92,253        60,429         53

Depreciation and amortization

     161,563        140,829         15
  

 

 

    

 

 

    

 

 

 

Total costs and expenses

   $ 476,321      $ 389,321         22
  

 

 

    

 

 

    

 

 

 

Operating expenses increased $28.6 million, or 25%, for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013, primarily to support the growth in our subscriber base. This increase was principally comprised of $10.9 million in equipment costs, which included a $1.3 million charge to write-off products never released for subscriber installations, $10.5 million in personnel costs within our monitoring, customer support and field service functions and a $5.1 million increase in cellular communications fees related to our monitoring services. In addition, we recognized a loss on impairment of $1.4 million associated with our CMS technology (See Note 8 to our accompanying unaudited condensed consolidated financial statements).

Selling expenses, excluding amortization of capitalized subscriber acquisition costs, increased $5.8 million, or 8%, for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013, primarily due to a $5.5 million increase in facility, administrative and information technology costs and a $1.0 million increase in advertising costs, all to support the expected increase in our subscriber contract originations. This increase is offset, in part, by a $0.9 million decrease in personnel costs.

General and administrative expenses increased $31.8 million, or 53%, for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013, partly due to a $19.6 million increase in personnel costs, primarily related to information technologies, research and development and management staffing to support the expected growth of the business and our wireless internet service. The increase was also due to a $7.7 million increase in brand recognition expenses, a $2.4 million increase in facility, administrative and information technology costs and a $0.9 million increase in insurance premiums and property taxes, all to support the growth in our business, along with a $3.1 million increase in the provision for doubtful accounts, primarily related to the growth in our accounts receivable. These increases were partially offset by a $3.7 million decrease in other advertising costs. In addition, in connection with the facility fire described in Note 10 of the accompanying condensed consolidated financial statements, we incurred an estimated $0.9 million of fire related losses, net of probable insurance recoveries.

Depreciation and amortization increased $20.7 million, or 15%, for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. The increase was primarily due to increased amortization of subscriber contract costs.

 

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Nine Months Ended September 30, 2014 Compared to the Nine Months Ended September 30, 2013—2GIG

All intercompany revenue and expenses between Vivint and 2GIG have been eliminated in consolidation and from the amounts presented below.

 

     Nine Months Ended September 30,        
     2014      2013     % Change  

Total revenue

   $ —         $ 17,507        NM   

Operating expenses

     —           11,667        NM   

General and administrative

     —           5,481        NM   

Other expenses

     —           2,138        NM   
  

 

 

    

 

 

   

 

 

 

Loss from operations

   $ —         $ (1,779     NM   
  

 

 

    

 

 

   

 

 

 

2GIG is no longer included in our results of operations, from the date of the 2GIG Sale.

Nine Months Ended September 30, 2014 Compared to the Nine Months Ended September 30, 2013—Consolidated

Other Expenses, net

 

     Nine Months Ended September 30,        
     2014     2013     % Change  

Interest expense

   $ 109,487     $ 83,309        31 %

Interest income

     (1,464 )     (1,087     35 %

Other expenses, net

     238       233        2 %

Gain on 2GIG Sale

     —          (47,122     -100
  

 

 

   

 

 

   

 

 

 

Total other expenses, net

   $ 108,261     $ 35,333        206 %
  

 

 

   

 

 

   

 

 

 

Interest expense increased $26.2 million, or 31%, for the nine months ended September 30, 2014, as compared with the nine months ended September 30, 2013, due to a higher principal balance on our debt resulting from the issuance of $550.0 million of senior unsecured notes payable since the beginning of 2013. During the nine months ended September 30, 2013, we realized a gain of $47.1 million as a result of the 2GIG Sale. See Note 3 of our unaudited Condensed Consolidated Financial Statements for additional information.

Income Taxes

 

     Nine Months Ended September 30,         
     2014     2013      % Change  

Income tax (benefit) expense

   $ (319 )   $ 11,598         -103

Income tax benefit for the nine months ended September 30, 2014 was $0.3 million compared with income tax expense of $11.6 million for the nine months ended September 30, 2013. After the 2GIG Sale on April 1, 2013, we were in a net deferred tax asset position, which required the application of a full valuation allowance against this deferred tax asset, resulting in income tax expense for the nine months ended September 30, 2013. Our tax benefit during the nine months ended September 30, 2014 was primarily due to the release of the valuation allowance as a result of the Space Monkey acquisition.

 

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Liquidity and Capital Resources

Our primary source of liquidity has historically been cash from operations, proceeds from the issuance of debt securities and borrowing availability under our revolving credit facility. As of September 30, 2014, we had $67.2 million of cash and $197.0 million of availability under our revolving credit facility (after giving effect to $3.0 million of letters of credit outstanding). On July 1, 2014, we issued and sold an additional $100.0 million of 8.75% senior notes due 2020. On October 10, 2014, in connection with the completion of its initial public offering, Solar repaid loans (See Note 4 of the accompanying condensed consolidated financial statements) to APX Group, Inc., our wholly-owned subsidiary, and our parent entity. Our parent entity, in turn, returned a portion of such proceeds to APX Group, Inc. as a capital contribution. These transactions resulted in the receipt by APX Group, Inc. of an aggregate amount of $55.0 million.

Cash Flow and Liquidity Analysis

Significant factors influencing our liquidity position include cash flows generated from monitoring and other fees received from the subscribers we service and the level of investment in capitalized subscriber acquisition costs. Our cash flows provided by operating activities include cash received from RMR, along with upfront activation fees, upgrade and other maintenance and repair fees. Cash used in operating activities includes the cash costs to monitor and service those subscribers, and certain costs, principally marketing and the portion of subscriber acquisition costs that are expensed and general and administrative costs. We have historically generated, and expect to continue generating, positive cash flows from operating activities. Historically, we financed subscriber acquisition costs through our operating cash flows, the issuance of debt, and to a lesser extent, through the issuance of equity and contract sales to third parties.

The direct-to-home sales are seasonal in nature. We make investments in the recruitment of our direct-to-home sales force and the inventory for the April through August sales period prior to each sales season. We experience increases in subscriber acquisition costs, as well as costs to support the sales force throughout North America, during this time period.

The following table provides a summary of cash flow data (dollars in thousands):

 

     Nine Months Ended
September 30,
       
     2014     2013     % Change  

Net cash provided by operating activities

   $ 91,656     $ 139,671        -34

Net cash used in investing activities

     (332,712 )     (140,722     136

Net cash provided by financing activities

     47,112       104,863        -55

Cash Flows from Operating Activities

We generally reinvest the cash flows from operating activities into our business, primarily to maintain and grow our subscriber base and to expand our infrastructure to support this growth and enhance our existing, and develop new, service offerings. These investments are focused on generating new subscribers, increasing the revenue from our existing subscriber base, enhancing the overall quality of service provided to our subscribers, increasing the productivity and efficiency of our workforce and back-office functions necessary to scale our business.

For the nine months ended September 30, 2014, net cash provided by operating activities was $91.7 million. This cash was primarily generated from a net loss of $173.0 million, adjusted for $169.8 million in non-cash amortization, depreciation and stock-based compensation, a $94.3 million increase in accrued expenses and other liabilities, primarily related to an increase in accrued interest payable and accrued payroll and commissions, and a $16.9 million increase in accounts payable. This was partially offset by a $32.0 million increase in inventories due to the timing of our inventory purchases and usage.

 

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For the nine months ended September 30, 2013, net cash provided by operating activities was $139.7 million. This cash was primarily generated from a net loss of $87.3 million, adjusted for $150.7 million in non-cash amortization, depreciation and stock-based compensation, a $100.0 million increase in accrued expenses and other liabilities and a $25.5 million increase in fees paid by subscribers in advance of when the associated revenue is recognized. This was partially offset by a $15.8 million increase in inventories due to the seasonality of our inventory purchases and usage.

Cash Flows from Investing Activities

Historically, our investing activities have primarily consisted of capitalized subscriber acquisition costs, capital expenditures, business combinations and technology acquisitions. Capital expenditures primarily consist of periodic additions to property and equipment to support the growth in our business.

For the nine months ended September 30, 2014 and 2013, net cash used in investing activities was $332.7 million and $140.7 million, respectively. For the nine months ended September 30, 2014, our cash used in investing activities primarily consisted of capitalized subscriber acquisition costs of $284.9 million, capital expenditures of $19.9 million, strategic acquisitions of $18.5 million related to Wildfire and Space Monkey and the acquisition of certain patents and other intangible assets of $6.4 million. For the nine months ended September 30, 2013, cash used in investing activities primarily consisted of $267.2 million of capitalized subscriber acquisition costs, partially offset by $144.8 million of proceeds from the 2GIG Sale.

Cash Flows from Financing Activities

Historically, our cash flows provided by financing activities primarily related to the issuance of debt to fund the portion of upfront costs associated with generating new subscribers that are not covered through our operating cash flows. Uses of cash for financing activities are generally associated with the payment of dividends to our investors and the repayment of debt.

For the nine months ended September 30, 2014, net cash provided by financing activities was $47.1 million, consisting primarily of $102.0 million in proceeds from the issuance of $100.0 million of senior unsecured notes payable, partially offset by $50.0 million of payments of dividends. For the nine months ended September 30, 2013, our net cash provided by financing activities was $203.5 million in proceeds from the issuance of $200.0 million of senior unsecured notes payable, $22.5 million of borrowings from our revolving line of credit, partially offset by $60.0 million of payments of dividends and $50.5 million of repayments of our revolving line of credit.

Long-Term Debt

We are a highly leveraged company with significant debt service requirements. As of September 30, 2014, we had approximately $1.9 billion of total debt outstanding, consisting of $925.0 million of 6.375% senior secured notes due 2019 (the “outstanding 2019 notes”), $930.0 million of 8.75% senior notes due 2020 (the “outstanding 2020 notes”) and no borrowings under the revolving credit facility.

Revolving Credit Facility

On November 16, 2012, we entered into a $200.0 million senior secured revolving credit facility, with a five year maturity, of which $197.0 million was undrawn and available as of September 30, 2014 (after giving effect to $3.0 million of outstanding letters of credit). In addition, we may request one or more term loan facilities, increased commitments under the revolving credit facility or new revolving credit commitments, in an aggregate amount not to exceed $225.0 million. Availability of such incremental facilities and/or increased or new commitments will be subject to certain customary conditions.

On June 28, 2013, we amended and restated the credit agreement to provide for a new repriced tranche of revolving credit commitments with a lower interest rate. Nearly all of the existing tranches of revolving credit commitments was terminated and converted into the repriced tranche, with the unterminated portion of the existing tranche continuing to accrue interest at the original higher rate.

 

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Borrowings under the revolving credit facility bear interest at a rate per annum equal to an applicable margin plus, at our option, either (1) the base rate determined by reference to the highest of (a) the Federal Funds rate plus 0.50%, (b) the prime rate of Bank of America, N.A. and (c) the LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month, plus 1.00% or (2) the LIBOR rate determined by reference to the London interbank offered rate for dollars for the interest period relevant to such borrowing. The applicable margin for base rate-based borrowings (1)(a) under the repriced tranche is currently 2.0% per annum and (b) under the former tranche is currently 3.0% and (2)(a) the applicable margin for LIBOR rate-based borrowings (a) under the repriced tranche is currently 3.0% per annum and (b) under the former tranche is currently 4.0%. The applicable margin for borrowings under the revolving credit facility is subject to one step-down of 25 basis points based on our consolidated first lien net leverage ratio at the end of each fiscal quarter, commencing with delivery of our consolidated financial statements for the first full fiscal quarter ending after the closing date.

In addition to paying interest on outstanding principal under the revolving credit facility, we are required to pay a quarterly commitment fee (which will be subject to one step-down based on our consolidated first lien net leverage ratio) to the lenders under the revolving credit facility in respect of the unutilized commitments thereunder. We also pay customary letter of credit and agency fees.

2019 Notes

On November 16, 2012, we issued $925.0 million of the 2019 notes. Interest on the 2019 notes is payable semi-annually in arrears on each June 1 and December 1, at an annual rate of 6.375%.

We may, at our option, redeem at any time and from time to time prior to December 1, 2015, some or all of the 2019 notes at 100% of their principal amount thereof plus accrued and unpaid interest to the redemption date plus a “make-whole premium.” Prior to December 1, 2015, during any 12 month period, we also may, at our option, redeem at any time and from time to time up to 10% of the aggregate principal amount of the issued 2019 notes at a price equal to 103% of the principal amount thereof, plus accrued and unpaid interest. From and after December 1, 2015, we may, at our option, redeem at any time and from time to time some or all of the 2019 notes at 104.781%, declining ratably on each anniversary thereafter to par from and after December 1, 2018, in each case, plus any accrued and unpaid interest to the date of redemption. In addition, on or prior to December 1, 2015, we may, at our option, redeem up to 35% of the aggregate principal amount of the 2019 notes with the proceeds from certain equity offerings at 106.37%, plus accrued and unpaid interest to the date of redemption.

2020 Notes

On November 16, 2012, we issued $380.0 million of 2020 notes. Interest on the outstanding 2020 notes is payable semi-annually in arrears on each June 1 and December 1, at an annual rate of 8.75%. During the year ended December 31, 2013, we issued an additional $450.0 million of 2020 notes and in July 2014, we issued an additional $100.0 million of 2020 notes.

We may, at our option, redeem at any time and from time to time prior to December 1, 2015, some or all of the 2020 notes at 100% of their principal amount thereof plus accrued and unpaid interest to the redemption date plus a “make-whole premium.” From and after December 1, 2015, we may, at our option, redeem at any time and from time to time some or all of the 2020 notes at 106.563%, declining ratably on each anniversary thereafter to par from and after December 1, 2018, in each case, plus any accrued and unpaid interest to the date of redemption. In addition, on or prior to December 1, 2015, we may, at our option, redeem up to 35% of the aggregate principal amount of the 2020 notes with the proceeds from certain equity offerings at 108.75%, plus accrued and unpaid interest to the date of redemption.

Guarantees and Security

All of our obligations under the revolving credit facility, the 2019 notes and the 2020 notes are guaranteed by APX Group Holdings, Inc. (“Parent Guarantor”) and each of our existing and future material wholly-owned U.S. restricted subsidiaries to the extent such entities guarantee indebtedness under the revolving credit

 

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facility or our other indebtedness. See Note 17 of our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for additional financial information regarding guarantors and non-guarantors.

The obligations under the revolving credit facility and the 2019 notes are secured by a security interest in (i) substantially all of the present and future tangible and intangible assets of APX Group, Inc., exclusive of its subsidiaries (the “Issuer”), and the guarantors, including without limitation equipment, subscriber contracts and communication paths, intellectual property, fee-owned real property, general intangibles, investment property, material intercompany notes and proceeds of the foregoing, subject to permitted liens and other customary exceptions, (ii) substantially all personal property of the Issuer and the guarantors consisting of accounts receivable arising from the sale of inventory and other goods and services (including related contracts and contract rights, inventory, cash, deposit accounts, other bank accounts and securities accounts), inventory and intangible assets to the extent attached to the foregoing books and records of the Issuer and the guarantors, and the proceeds thereof, subject to permitted liens and other customary exceptions, in each case held by the Issuer and the guarantors and (iii) a pledge of all of the Capital Stock of the Issuer, each of its subsidiary guarantors and each restricted subsidiary of the Issuer and its subsidiary guarantors, in each case other than excluded assets and subject to the limitations and exclusions provided in the applicable collateral documents.

Under the terms of the applicable security documents and intercreditor agreement, the proceeds of any collection or other realization of collateral received in connection with the exercise of remedies will be applied first to repay amounts due under the revolving credit facility, and up to an additional $150.0 million of “superpriority” obligations that we may incur in the future, before the holders of the 2019 notes receive any such proceeds.

Debt Covenants

The credit agreement governing the revolving credit facility and the indentures governing the notes contain a number of covenants that, among other things, restrict, subject to certain exceptions, our and our restricted subsidiaries’ ability to:

 

    incur or guarantee additional debt or issue disqualified stock or preferred stock;

 

    pay dividends and make other distributions on, or redeem or repurchase, capital stock;

 

    make certain investments;

 

    incur certain liens;

 

    enter into transactions with affiliates;

 

    merge or consolidate;

 

    enter into agreements that restrict the ability of restricted subsidiaries to make dividends or other payments to the Issuer;

 

    designate restricted subsidiaries as unrestricted subsidiaries; and

 

    transfer or sell assets.

The credit agreement governing the revolving credit facility and the indentures governing the notes contain change of control provisions and certain customary affirmative covenants and events of default. As of September 30, 2014, we were in compliance with all restrictive covenants related to our long-term obligations.

Subject to certain exceptions, the credit agreement governing the revolving credit facility and the indentures governing the notes permit us and our restricted subsidiaries to incur additional indebtedness, including secured indebtedness.

 

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Our future liquidity requirements will be significant, primarily due to debt service requirements. The actual amounts of borrowings under the revolving credit facility will fluctuate from time to time. We believe that amounts available through our revolving credit facility and incremental facilities will be sufficient to meet our operating needs for the next twelve months, including working capital requirements, capital expenditures, debt repayment obligations and potential new acquisitions.

As market conditions warrant, we and our major equity holders, including the Sponsor and its affiliates, may from time to time, seek to repurchase debt securities that we have issued or loans that we have borrowed, including the notes and borrowings under our revolving credit facility, in privately negotiated or open market transactions, by tender offer or otherwise.

Covenant Compliance

Under the indentures governing our notes and the credit agreement governing our revolving credit facility, our ability to engage in activities such as incurring additional indebtedness, making investments, refinancing certain indebtedness, paying dividends and entering into certain merger transactions is governed, in part, by our ability to satisfy tests based on Adjusted EBITDA.

“Adjusted EBITDA” is defined as net income (loss) before interest expense (net of interest income), income and franchise taxes and depreciation and amortization (including amortization of capitalized subscriber acquisition costs), further adjusted to exclude the effects of certain contract sales to third parties, non-capitalized subscriber acquisition costs, stock based compensation and certain unusual, non-cash, non-recurring and other items permitted in certain covenant calculations under the indentures governing our notes and the credit agreement governing our revolving credit facility.

We believe that the presentation of Adjusted EBITDA is appropriate to provide additional information to investors about the calculation of, and compliance with, certain financial covenants in the indentures governing our notes and the credit agreement governing our revolving credit facility. We caution investors that amounts presented in accordance with our definition of Adjusted EBITDA may not be comparable to similar measures disclosed by other issuers, because not all issuers and analysts calculate Adjusted EBITDA in the same manner.

Adjusted EBITDA is not a measurement of our financial performance under GAAP and should not be considered as an alternative to net income (loss) or any other performance measures derived in accordance with GAAP or as an alternative to cash flows from operating activities as a measure of our liquidity.

 

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The following table sets forth a reconciliation of net loss before non-controlling interests to Adjusted EBITDA (in thousands):

 

     Three Months Ended
September 30,

2014
    Nine Months Ended
September 30,

2014
    Twelve Months
Ended September 30,
2014
 

Net loss

   $ (59,464   $ (173,015   $ (210,187

Interest expense, net

     37,795        108,023        138,784   

Other expense (income), net

     535        238        (71

Income tax benefit

     (1,264     (319     (8,325

Depreciation and amortization (1)

     40,765        121,242        164,383   

Amortization of capitalized creation costs

     17,082        40,320        49,719   

Non-capitalized subscriber acquisition costs (2)

     35,949        96,680        119,615   

Non-cash compensation (3)

     460        1,363        1,945   

Other adjustments (4)

     6,901        30,759        49,263   
  

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 78,759      $ 225,291      $ 305,126   
  

 

 

   

 

 

   

 

 

 

 

(1) Excludes loan amortization costs that are included in interest expense.
(2) Reflects subscriber acquisition costs that are expensed as incurred because they are not directly related to the acquisition of specific subscribers. Certain other industry participants purchase subscribers through subscriber contract purchases, and as a result, may capitalize the full cost to purchase these subscriber contracts, as compared to our organic generation of new subscribers, which requires us to expense a portion of our subscriber acquisition costs under GAAP.
(3) Reflects non-cash compensation costs related to employee and director stock and stock option plans.
(4) Other adjustments represent primarily the following items (in thousands):

 

     Three Months Ended
September 30,

2014
    Nine Months Ended
September 30,

2014
     Twelve Months
Ended September 30,
2014
 

Product development (a)

   $ 2,394      $ 9,382       $ 13,717   

Start-up of new strategic initiatives (b)

     1,909        2,741         4,395   

Purchase accounting deferred revenue fair value adjustment (c)

     1,271        4,028         5,498   

Monitoring fee (d)

     1,144        2,589         2,026   

One-time compensation-related payments

     653        1,952         2,782   

Information technology implementation (e)

     358        2,492         3,722   

Subcontracted monitoring agreement (f)

     —          2,225         3,303   

CMS technology impairment loss (g)

     —          1,351         1,351   

Non-cash contingent liabilities

     —          —           6,500   

Fire related losses, net of probable insurance recoveries (h)

     (1,778     881         881   

Non-operating legal and professional fees

     (297     822         1,630   

All other adjustments

     1,247        2,296         3,458   
  

 

 

   

 

 

    

 

 

 

Total other adjustments

   $ 6,901      $ 30,759       $ 49,263   
  

 

 

   

 

 

    

 

 

 

 

(a) Costs related to the development of future products and services, including associated software.
(b) Costs related to the start-up of potential new service offerings and sales channels.
(c) Add back revenue reduction directly related to purchase accounting deferred revenue adjustments.
(d) Blackstone Management Partners L.L.C monitoring fee (See Note 14 to the accompanying unaudited condensed consolidated financial statements).
(e) Costs related to the implementation of new information technologies.
(f) Run-rate savings from committed future reductions in subcontract monitoring fees.
(g) CMS technology impairment loss (See Note 8 to the accompanying unaudited condensed consolidated financial statements).
(h) Fire relates losses, net of insurance recoveries of $6.2 million considered probable at September 30, 2014. (See Note 10 to the accompanying unaudited condensed consolidated financial statements).

 

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Other Factors Affecting Liquidity and Capital Resources

Vehicle Leases. Since 2010, we have leased, and expect to continue leasing, vehicles primarily for use by our field service technicians. For the most part, these leases have 36 month durations and we account for them as capital leases. At the end of the lease term for each vehicle we have the option to either (i) purchase it for the estimated end-of-lease fair market value established at the beginning of the lease term; or (ii) return the vehicle to the lessor to be sold by them and in the event the sale price is less than the estimated end-of-lease fair market value we are responsible for such deficiency. As of September 30, 2014, our total capital lease obligations were $13.3 million, of which $4.3 million is due within the next 12 months.

Aircraft Lease. In December 2012, we entered into an aircraft lease agreement for the use of a corporate aircraft, which is accounted for as an operating lease. Upon execution of the lease, we paid a $5.9 million security deposit which is refundable at the end of the lease term. Beginning January 2013, we are required to make 156 monthly rental payments of approximately $83,000 each. We also have the option to extend the lease for an additional 36 months upon expiration of the initial term. The lease agreement also provides us the option to purchase the aircraft on certain specified dates for a stated dollar amount, which represents the current estimated fair value as of the purchase date.

Off-Balance Sheet Arrangements

Currently we do not engage in off-balance sheet financing arrangements.

Critical Accounting Estimates

In preparing our unaudited Condensed Consolidated Financial Statements, we make assumptions, judgments and estimates that can have a significant impact on our revenue, income (loss) from operations and net loss, as well as on the value of certain assets and liabilities on our unaudited Condensed Consolidated Balance Sheets. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. At least quarterly, we evaluate our assumptions, judgments and estimates and make changes accordingly. Historically, our assumptions, judgments and estimates relative to our critical accounting estimates have not differed materially from actual results. We believe that the assumptions, judgments and estimates involved in the accounting for income taxes, allowance for doubtful accounts, valuation of intangible assets, and fair value have the greatest potential impact on our unaudited Condensed Consolidated Financial Statements; therefore, we consider these to be our critical accounting estimates. For information on our significant accounting policies, see Note 1 to our unaudited Condensed Consolidated Financial Statements.

Revenue Recognition

We recognize revenue principally on three types of transactions: (i) monitoring, which includes RMR, (ii) service and other sales, which includes non-recurring service fees charged to our subscribers provided on contracts, contract fulfillment revenues and sales of products that are not part of our service offerings, and (iii) activation fees on the subscriber contracts, which are amortized over the estimated life of the subscriber relationship.

Monitoring services for our subscriber contracts are billed in advance, generally monthly, pursuant to the terms of subscriber contracts and recognized ratably over the service period. RMR is recognized monthly as services are provided in accordance with the rates set forth in our subscriber contracts. Costs of providing ongoing monitoring services are expensed in the period incurred.

Any services included in service and other sales revenue are recognized upon provision of the applicable services. Revenue from 2GIG product sales was recognized when title passed to the customer, which was generally upon shipment from the warehouse of our third-party logistics provider. Revenue generated by Vivint from the sale of products that are not part of the service offerings is recognized upon installation. Contract fulfillment revenue represents fees received from subscribers at the time of, or subsequent to, the in-term termination of their contract. This revenue is recognized when payment is received from the subscriber.

 

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Activation fees are typically charged upon the generation of a new subscriber. This revenue is deferred and recognized over a pattern that reflects the estimated life of a subscriber relationship.

Revenue from the sale of subscriber contracts to third parties is recognized when ownership of the contracts has transferred to the purchaser. Any unamortized deferred revenue and costs related to contract sales are recognized at that time of the sale.

Subscriber Acquisition Costs

A portion of the direct costs of acquiring new subscribers, primarily sales commissions, equipment, and installation costs, are deferred and recognized over a pattern that reflects the estimated life of the subscriber relationships. We amortize these costs over the estimated useful life using a 150% declining balance method over 12 years and convert to a straight-line methodology when the resulting amortization charge is greater than that from the accelerated method for the remaining estimated life. We evaluate attrition on a periodic basis, utilizing observed attrition rates for our subscriber contracts and industry information and, when necessary, make adjustments to the estimated life of the subscriber relationship and amortization method.

Subscriber acquisition costs represent the costs related to the origination of new subscribers. A portion of subscriber acquisition costs is expensed as incurred, which includes costs associated with the direct-to-home sale housing, marketing and recruiting, certain portions of sales commissions (residuals), overhead and other costs, considered not directly and specifically tied to the origination of a particular subscriber. The remaining portion of the costs is considered to be directly tied to subscriber acquisition and consist primarily of certain portions of sales commissions, equipment, and installation costs. These costs are deferred and recognized in a pattern that reflects the estimated life of the subscriber relationships. Subscriber acquisition costs are largely correlated to the number of new subscribers originated.

Accounts Receivable

Accounts receivables consist primarily of amounts due from subscribers for RMR services. Accounts receivable are recorded at invoiced amounts and are non-interest bearing. The gross amount of accounts receivable has been reduced by an allowance for doubtful accounts of approximately $3.3 million and $1.9 million at September 30, 2014 and December 31, 2013, respectively. We estimate this allowance based on historical collection rates, attrition rates, and contractual obligations underlying the sale of the subscriber contracts to third parties. As of September 30, 2014 and December 31, 2013, no accounts receivable were classified as held for sale. Provision for doubtful accounts recognized and included in general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations totaled $4.0 million and $2.9 million for the three months ended September 30, 2014 and 2013, respectively, and $11.3 million and $8.3 million for the nine months ended September 30, 2014 and 2013, respectively.

Loss Contingencies

We record accruals for various contingencies including legal proceedings and other claims that arise in the normal course of business. The accruals are based on judgment, the probability of losses and, where applicable, the consideration of opinions of legal counsel. We record an accrual when a loss is deemed probable to occur and is reasonably estimable. Factors that we consider in the determination of the likelihood of a loss and the estimate of the range of that loss in respect of legal matters include the merits of a particular matter, the nature of the litigation, the length of time the matter has been pending, the procedural posture of the matter, whether we intend to defend the matter, the likelihood of settling for an insignificant amount and the likelihood of the plaintiff accepting an amount in this range. However, the outcome of such legal matters is inherently unpredictable and subject to significant uncertainties.

 

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Goodwill and Intangible Assets

Purchase accounting requires that all assets and liabilities acquired in a transaction be recorded at fair value on the acquisition date, including identifiable intangible assets separate from goodwill. For significant acquisitions, we obtain independent appraisals and valuations of the intangible (and certain tangible) assets acquired and certain assumed obligations as well as equity. Identifiable intangible assets include customer relationships, trade names and trademarks and developed technology, which equaled $740.2 million at September 30, 2014. Goodwill represents the excess of cost over the fair value of net assets acquired and was $842.7 million at September 30, 2014.

The estimated fair values and useful lives of identified intangible assets are based on many factors, including estimates and assumptions of future operating performance and cash flows of the acquired business, estimates of cost avoidance, the nature of the business acquired, the specific characteristics of the identified intangible assets and our historical experience and that of the acquired business. The estimates and assumptions used to determine the fair values and useful lives of identified intangible assets could change due to numerous factors, including product demand, market conditions, regulations affecting the business model of our operations, technological developments, economic conditions and competition. The carrying values and useful lives for amortization of identified intangible assets are reviewed annually during our fourth fiscal quarter and as necessary if changes in facts and circumstances indicate that the carrying value may not be recoverable and any resulting changes in estimates could have a material adverse effect on our financial results.

When we determine that the carrying value of intangible assets, goodwill and long-lived assets may not be recoverable, an impairment charge is recorded. Impairment is generally measured based on valuation techniques considered most appropriate under the circumstances, including a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model or prevailing market rates of investment securities, if available.

We conduct a goodwill impairment analysis annually in our fourth fiscal quarter, and as necessary if changes in facts and circumstances indicate that the fair value of our reporting units may be less than their carrying amount. Under applicable accounting guidance, we are permitted to use a qualitative approach to evaluating goodwill impairment when no indicators of impairment exist and if certain accounting criteria are met. To the extent that indicators exist or the criteria are not met, we use a quantitative approach to evaluate goodwill impairment. Such quantitative impairment assessment is performed using a two-step, fair value based test. The first step requires that we compare the estimated fair value of our reporting units to the carrying value of the reporting unit’s net assets, including goodwill. If the fair value of the reporting unit is greater than the carrying value of its net assets, goodwill is not considered to be impaired and no further testing is required. If the fair value of the reporting unit is less than the carrying value of its net assets, we would be required to complete the second step of the test by analyzing the fair value of its goodwill. If the carrying value of the goodwill exceeds its fair value, an impairment charge is recorded.

Property and Equipment

Property and equipment are stated at cost and depreciated on the straight-line method over the estimated useful lives of the assets or the lease term, whichever is shorter. Amortization expense associated with leased assets is included with depreciation expense. Routine repairs and maintenance are charged to expense as incurred. We periodically assess potential impairment of our property and equipment and perform an impairment review whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

Income Taxes

We account for income taxes based on the asset and liability method. Under the asset and liability method, deferred tax assets and deferred tax liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards. Valuation allowances are established when necessary to reduce deferred tax assets when it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized.

 

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We recognize the effect of an uncertain income tax position on the income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Our policy for recording interest and penalties is to record such items as a component of the provision for income taxes.

Recent Accounting Pronouncements

In May 2014, the FASB issued authoritative guidance which clarifies the principles used to recognize revenue for all entities. The new guidance requires companies to recognize revenue when it transfers goods or services to a customer in an amount that reflects the consideration to which a company expects to be entitled. The guidance is effective for annual and interim periods beginning after December 15, 2016. The guidance allows for either a “full retrospective” adoption or a “modified retrospective” adoption, however early adoption is not permitted. We are currently evaluating the impact the adoption of this guidance will have on our consolidated financial statements.

In February 2013, the FASB issued authoritative guidance which expands the disclosure requirements for amounts reclassified out of accumulated other comprehensive income (“AOCI”). The guidance requires an entity to provide information about the amounts reclassified out of AOCI by component and present, either on the face of the income statement or in the notes to financial statements, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. This guidance does not change the current requirements for reporting net income or OCI in financial statements. The guidance became effective for us in the first quarter of fiscal year 2014. The adoption of this guidance did not have a material impact on our financial position, results of operations or cash flows.

In July 2013, the FASB issued authoritative guidance which amends the guidance related to the presentation of unrecognized tax benefits and allows for the reduction of a deferred tax asset for a net operating loss carryforward whenever the net operating loss carryforward or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. This guidance became effective for us for annual and interim periods beginning in fiscal year 2014. The adoption of this guidance did not have a material impact on our financial position, results of operations or cash flows.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our operations include activities in the United States, Canada and New Zealand. These operations expose us to a variety of market risks, including the effects of changes in interest rates and foreign currency exchange rates. We monitor and manage these financial exposures as an integral part of our overall risk management program.

Interest Rate Risk

On November 16, 2012, we entered into a revolving credit facility which we amended and restated on June 20, 2013. As amended and restated, the revolving credit facility bears interest at a floating rate. As a result, we may be exposed to fluctuations in interest rates to the extent of our borrowings under the revolving credit facility. Our long-term debt portfolio is expected to primarily consist of fixed rate instruments. To help manage borrowing costs, we may from time to time enter into interest rate swap transactions with financial institutions acting as principal counterparties. Assuming the borrowing of all amounts available under our revolving credit facility, if interest rates related to our revolving credit facility increase by 1% due to normal market conditions, our interest expense will increase by approximately $2.0 million per annum.

We had no borrowings under the revolving credit facility as of September 30, 2014.

 

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Foreign Currency Risk

We have exposure to the effects of foreign currency exchange rate fluctuations on the results of our Canadian operations. Our Canadian operations use the Canadian dollar to conduct business but our results are reported in U.S. dollars. Our operations in New Zealand are immaterial to our overall operating results. We are exposed periodically to the foreign currency rate fluctuations that affect transactions not denominated in the functional currency of our U.S. and Canadian operations. We do not use derivative financial instruments to hedge investments in foreign subsidiaries since such investments are long-term in nature.

 

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2014, the end of the period covered by this report. Based upon that evaluation, our principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the design and operation of our disclosure controls and procedures were effective to accomplish their objectives at the reasonable assurance level.

Internal Control Over Financial Reporting

Internal Control Procedures

During the year ended December 31, 2013, we implemented a company employee service portal. Functionality within this portal calculates certain expense items related to employee payroll. Additionally, during the nine months ended September 30, 2014, we implemented Customer Service, Customer Billing and Inventory systems. During the remainder of the year we will continue to enhance these systems and continue to improve and enhance supporting internal controls. We believe the systems, as implemented, and our current system of internal control over financial reporting continue to provide reasonable assurance our financial reporting is accurate and our established policies are followed.

Because of its inherent limitations, internal control over financial reporting, including disclosure controls, may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Changes in Internal Control Over Financial Reporting

Except as described above, there have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended September 30, 2014 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

 

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Part II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

We are engaged in the defense of certain claims and lawsuits arising out of the ordinary course and conduct of our business and have certain unresolved claims pending, the outcomes of which are not determinable at this time. Our subscriber contracts include exculpatory provisions as described under “—Subscriber Contracts—Other Terms” in our Annual Report on Form 10-K. We also have insurance policies covering certain potential losses where such coverage is available and cost effective. In our opinion, any liability that might be incurred by us upon the resolution of any claims or lawsuits will not, in the aggregate, have a material adverse effect on our financial condition or results of operations. See Note 13 of our unaudited Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q for additional information.

 

ITEM 1A. RISK FACTORS

For a discussion of the Company’s potential risks or uncertainties, please see “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 (the “Annual Report”). Except as set forth below, there have been no material changes to the risk factors disclosed in the Annual Report.

We have amended and restated the risk factor captioned, “We must successfully upgrade and maintain our information technology systems” to read as follows:

We rely on various information technology systems to manage our operations. We are currently implementing modifications and upgrades to these systems, including making changes to legacy systems, replacing legacy systems with successor systems with new functionality and implementing new systems.

There are inherent costs and risks associated with replacing and changing these systems and implementing new systems, including potential disruption of our internal control structure, substantial capital expenditures, additional administration and operating expenses, retention of sufficiently skilled personnel to implement and operate the new systems, demands on management time and other risks and costs of delays or difficulties in transitioning to new systems or of integrating new systems into our current systems. For example, we encountered issues associated with the implementation of our new customer service, customer billing and inventory system (the “JARVIS System”), which resulted in an immaterial error in our financial statements for the quarter ended June 30, 2014. While we have corrected such error during the quarter ended September 30, 2014 and expect to fully remediate the JARVIS System issues identified in fiscal 2014, we can provide no assurance that our remediation efforts will be successful or that we will not encounter additional issues as we complete the implementation of these and other systems. In addition, our information technology system implementations may not result in productivity improvements at a level that outweighs the costs of implementation, or at all. In addition, the implementation of new information technology systems may cause disruptions in our business operations and have an adverse effect on our business, cash flows and operations.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

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Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012, which added Section 13(r) of the Exchange Act, the Company hereby incorporates by reference herein Exhibit 99.1 of this report, which includes disclosures publicly filed and/or provided to the Blackstone Group L.P., an affiliate of our major shareholders, by Travelport Worldwide Limited which may be considered the Company’s affiliate.

 

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ITEM 6. EXHIBITS

Exhibits

 

         

Incorporated by Reference

 

Exhibit
Number

  

Exhibit Title

  

Form

  

File No.

  

Exhibit
No.

  

Filing Date

  

Provided
Herewith

 
  31.1    Certification of the Registrant’s Chief Executive Officer, Todd Pedersen, pursuant to Rule 13a-14 of the Securities Exchange Act of 1934                  X   
  31.2    Certification of the Registrant’s Principal Financial Officer, Mark Davies, pursuant to Rule 13a-14 of the Securities Exchange Act of 1934                  X   
  32.1    Certification of the Registrant’s Chief Executive Officer, Todd Pedersen, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                  X   
  32.2    Certification of the Registrant’s Principal Financial Officer, Mark Davies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                  X   
  99.1    Section 13(r) Disclosure                  X   
101.INS    XBRL Instance Document.                  X   
101.SCH    XBRL Taxonomy Extension Schema Document.                  X   
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document.                  X   
101.DEF    XBRL Taxonomy Extension Schema Document.                  X   
101.LAB    XBRL Taxonomy Extension Label Linkbase Document.                  X   
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document.                  X   

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    APX Group Holdings Inc.
Date: November 13, 2014     By:   /S/ TODD PEDERSEN
      Todd Pedersen
     

Chief Executive Officer and Director

(Principal Executive Officer)

Date: November 13, 2014     By:   /S/ MARK DAVIES
      Mark Davies
     

Chief Financial Officer

(Principal Financial Officer)

 

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